UPDATE 2-Turkish central bank raises rates to stem lira outflows
ISTANBUL, July 23 (Reuters) - Turkey's central bank raised interest rates on Tuesday and said it would, if necessary, take further steps to stop the lira from falling.
The move - a rise in the overnight lending rate to 7.25 percent from 6.5 percent - was a reaction to capital outflows that have knocked the lira down as much as 9 percent against the dollar.
Uncertainty over the continuation of the U.S. Federal Reserve's bond-buying programme has hit emerging markets in general. Turkish investments were also shaken by demonstrations last month against Prime Minister Tayyip Erdogan's government.
The bank kept its one-week repo policy rate at 4.5 percent and its borrowing rate at 3.5 percent.
The lira strengthened to 1.9081 against the dollar from 1.9153 beforehand. The 10-year bond yield fell to 8.49 percent from 8.69 percent.
Erdogan has long championed low interest rates, fearing an economic slowdown ahead of elections. But the central bank has already burned through $6.6 billion of its reserves this year to try to boost the lira, a policy it cannot pursue indefinitely, making rate hikes its clearest alternative.
Analysts said the bank's view on the outlook for rates would be more important than the size of the expected hike itself.
"The rates may need to go higher if market stress continues. The central bank has probably done the minimum it needed to do," said Neil Shearing, chief economist at Capital Economics.
Erdogan and members of his economic team have blamed a "high interest rate lobby" for seeking to undermine Turkey's prospects.
Central bank Governor Erdem Basci, however, signalled a possible shift in policy last week.
Speaking a day after Erdogan met his economy and finance ministers, Basci said a "measured step" was on the cards to widen the interest rate corridor the bank uses to control liquidity conditions, widely interpreted to mean a hike in its overnight lending rate.
Deputy Prime Minister Ali Babacan has repeatedly said the central bank is fully independent, but the timing of Basci's announcement left some with the impression he had been emboldened to act after receiving the government's blessing.
FORWARD GUIDANCE KEY
Reassurances from Fed Chairman Ben Bernanke last week over the pace of the U.S. central bank's plans to withdraw monetary stimulus have boosted sentiment in emerging markets, lending support to the lira in recent days and taking some pressure off Turkey's central bank.
It nonetheless followed other emerging markets in lifting rates. Last week, India joined Brazil and Indonesia in raising some of its interest rates to try to prevent a rout of its currency.
Raising the overnight lending rate increases the real interest rate on lira assets and makes them more attractive to foreign investors, supporting the currency. Whether that in itself will be enough to calm nerves remains to be seen.
"Even with this rate hike we expect the central bank to tread carefully: Growth is still fragile and PM Erdogan will not be too happy with the central bank quenching growth, considering the upcoming elections," said Nordea Bank analyst Annika Lindblad.