Focus turns to policy tightening

The sharp fall in the Turkish lira has forced the central bank to tinker with its monetary policy setup in an effort to shore up the currency, and we think hikes in key policy interest rates loom. Earlier this month, the Bank lowered reserve requirement ratios on FX-denominated liabilities to provide banks with more foreign currency liquidity. And it forced banks to turn to yet another liquidity-provision facility (the late liquidity window), which carries a higher interest rate, in order to raise interbank rates. We expect the MPC to raise its policy interest rates by 100bp at the scheduled meeting later today. But a failure to do so (or further attempts to tighten policy via unconventional means) would give the impression that the Council is bowing to government pressure to keep interest rates low, and would probably result in further lira falls. Elsewhere in the region, the rise in headline inflation in Central Europe at the end of last year has turned attention to the timing of policy tightening, although it seems that central banks will largely look through this. At the other end of the spectrum, falling inflation and inflation expectations in Russia mean the central bank could resume its easing cycle earlier than most expect. We have pencilled in a cautious 25bp cut in early February.