This record is a partial extract of the original cable. The full text of the original cable is not available.

UNCLAS SECTION 01 OF 02 ANKARA 007105 
 
SIPDIS 
 
SENSITIVE 
 
TREASURY FOR INTERNATIONAL AFFAIRS - RADKINS AND MMILLS 
NSC FOR BRYZA AND MCKIBBEN 
 
E.O. 12958: N/A 
TAGS: EFIN ECON TU
SUBJECT: EU DECISION PROMPTS MARKET RALLY AND INTEREST RATE 
CUT 
 
REF: A. ANKARA 7000 
 
     ¶B. ANKARA 6947 
     ¶C. ANKARA 6700 
 
¶1. (SBU) Summary:  The EU decision to give Turkey a date for 
accession negotiations, underpinned by the news earlier in 
the week of a new IMF program, sparked a rally in Turkish 
financial markets.  Though the markets ended up on Friday, 
confusion over what was really happening in Brussels created 
uncertainty, and the big rally for the lira and government 
securities, came Monday.  The Central Bank accommodated and 
encouraged the market with a 2 percentage point cut in 
short-term rates early Monday and announced it would resume 
its foreign exchange purchase auctions this week, without 
waiting for the new year.  The Central Bank also publicly 
confirmed that it would move to formal inflation targeting as 
of January 1, 2006, as agreed in the IMF program.  The 
confluence of good news leaves the market in a bullish mood 
heading into 2005. End Summary. 
 
Market confusion over EU decision Friday: 
----------------------------------------- 
 
¶2. (SBU) After hesitating earlier in the week over the 
confusing EU news flow, markets moved up Thursday and Friday, 
betting on a positive outcome in Brussels. On Friday, markets 
had a rough time figuring out what was really happening in 
Brussels. Markets opened lower on fears the discussions were 
going badly, then worked their way back up to close up on 
increasingly positive hints--but no confirmation by the 
close--that Turkey had reached an understanding with the EU 
Council.  The uncertainty during the day, and the importance 
of the decision, resulted in a huge (TL 2.1 Quadrillion or 
$1.5 billion) trading volume.  In the end, the IMKB 100 stock 
price index hit a new record, at 24,503. The increase from 
Thursday's close was only 0.58% increase, following the 1.78% 
surge on Thursday.  The lira, despite falling at the opening 
Friday ended up pretty much where it started at 1.403 million 
to the dollar and 1.891 to the Euro.  Though Thursday's 
optimism had caused the interest rate on the benchmark July 
5, 2006 bond to come down 91 basis points, from 23.27% to 
22.36%, Friday's uncertainty caused the bond to give up half 
of this gain, as the rate rose 44 basis points to 22.80%. 
 
 
EU decision and Interest Rate Cut Cause a Rally in Lira and 
Bonds Monday: 
------------------------------------------ 
 
¶3. (SBU) Having digested the confirmation of the EU decision, 
the markets opened with a bang Monday. They were quickly 
given an assist by Central Bank Governor Serdengecti, who 
announced an interest rate cut early in the trading day (see 
below).  The lira broke out of what had been its trading 
range, strengthening on the day against both dollar and euro, 
ending up at 1.386 million to the dollar and 1.855 million to 
the euro.  The Central Bank interest cut helped the benchmark 
bond interest rate to fall 150 basis points on the day. 
Though this was less than the 200 basis point cut on the 
Central Bank's overnight rate, it represents a 206 basis 
point fall since the close on December 14.  Though the rate 
cut is for the shortest maturities, it tends to bring down 
the entire yield curve, as banks fund their purchases of 
longer-dated paper with short-term deposits (ref a). The 
stock market, on the other hand, though it started to move up 
in the morning, ended the day Monday almost flat with a loss 
of 0.08% at 24,341. 
 
 
¶4. (SBU) The rally was both accommodated and given impetus by 
a Central Bank announcement early Monday that it was cutting 
its simple overnight borrowing rate from 20% to 18%.  For 
months analysts had been predicting a further rate cut by 
yearend, ranging between 100 and 200 basis points.  The 
Central Bank, however, has a track record of waiting until 
positive reform-linked events are confirmed (such as IMF 
reviews, or the EU decision) before cutting rates as a way of 
maintaining pressure on the GOT to stay on the reform track. 
True to form, the Bank waited for the IMF and EU 
announcements before moving to cut rates.  The markets wait 
was rewarded both by the cut being at the top of the expected 
range.  By one analyst's calculation, ex ante real interest 
rates are now only 10.3%, the lowest level since the 
introduction of implicit inflation targeting after the 2001 
financial crisis. 
 
Resumption of Foreign Exchange Purchase Auctions: 
--------------------------------------------- --- 
¶5. (SBU)  The market was also pleased with the Central Bank's 
announcements about resuming foreign exchange purchases. 
Taking advantage of favorable market conditions (i.e. strong 
inflows of foreign exchange), the Central Bank announced it 
would resume its foreign exchange purchase auctions on 
Wednesday, December 22.  The Bank had agreed with the IMF on 
the desirability of resuming these auctions, which will allow 
the Central Bank to build up reserves in anticipation of 
large external debt payments coming in 2005.  But it only 
made a public announcement on Monday, and moved up the start 
date to this week because of the rally.  The Central Bank and 
IMF have worked out a change in approach, in the hope of 
avoiding of the problem the Bank ran into in April, when the 
unlucky timing of a change in the amount purchased left 
market participants angry at the Central Bank for 
exacerbating a sell-off. 
 
¶6. (SBU) The new plan is to make smaller but more frequent 
purchase, that will be known in advance to the market.  The 
Central Bank announced it would buy $15 million of foreign 
exchange each trading day, with the Bank having the option of 
buying up to $30 million more from the winner of the auction. 
 Analysts considered the auction resumption to be 
market-positive--some thought it was even more important than 
the rate cut--because it will inject needed liquidity into 
the lira market.  Some analysts attributed the relatively 
slow fall in interest rates to the recent decline in lira 
liquidity.  As it has before, the Bank stressed that its goal 
was to build up reserves rather than to try to influence the 
exchange rate.  The IMF and the Bank hope that announcing in 
advance a modest sum of daily purchases, the Central Bank's 
needed reserve build-up will have less of a market-distorting 
impact. 
 
Formal Inflation Targeting in 2006: 
---------------------------------- 
 
¶7. (SBU) The Bank also publicly announced its decision to 
move to formal inflation targeting (as opposed to informal, 
or implicit inflation targeting) as of January 1, 2006, and 
to institutionalize the monetary policy decision-making 
process and make it more transparent.  Whereas the volatility 
of money supply in Turkey's volatile, high-inflation, 
environment had made it difficult for the Bank to set formal 
inflation targets, it will begin to do so on January 1, 2006. 
 The IMF had long been urging the Central Bank to move to 
formal inflation-targeting, but, as he had told us privately, 
Central Bank Governor Serdengecti worried that the Bank 
needed to be very cautious before making this move. If it 
went badly, he argued, the Bank had no other policy options 
left. 
 
¶8. (SBU) The moves to a more transparent and 
institutionalized decision-making process bring Turkish 
monetary policy in line with international practice.  The 
Bank announced that, beginning in 2005, it will make monetary 
policy decisions at a monetary policy committee meeting to be 
held the eighth of each month. The monetary policy commmittee 
will continue to be merely advisory in 2005, with the 
Governor making the decisions.  In 2006, however, the 
committee will gain formal decision-making powers. 
 
Bullish Mood Heading into 2005: 
------------------------------ 
 
¶9. (SBU) Comment: The markets perceive the EU decision as a 
huge positive, as it it is viewed as ensuring greater 
stability and continuity of economic reform.  Indeed, the 
size of the rally understates the importance to market 
participants, since they had priced in a high probability of 
a successful outcome.  Coupled with the IMF announcement and 
encouraging macro data releases in recent weeks, the markets 
end 2004 on a very positive note. 
 
 
 
 
 
DEUTSCH