The Turkish central bank (CBRT) continued to cut benchmark interest rates yesterday, bringing down the one-week repo rate to 4.50% with a 50bp cut (overnight borrowing rate cut to 3.50%, overnight lending rate to 6.50%). The CBRT also continued to hike its FX reserve coefficient and reserve option coefficients (ROCs) to control liquidity.

The interest rate cuts have been aimed at shoring up the slowing economy, but the trigger for cuts has been the real effective exchange rate of the lira. A too strong TRY has prompted the central bank to cut rates. A stronger lira would be negative for exports but positive for imports, which would create problems with Turkey’s current account deficit – currently the largest short-term risk factor.

Later in the evening yesterday the TRY picture was, however, complicated by Moody’s raising Turkey’s credit rating to investment grade (Baa3). Moody’s motivated the decision with structural improvements in the economy as well as strengthening public finances. Turkey now has two investment grade ratings (Fitch (BBB-) & Moody’s) from the three major ratings agencies (Fitch & Moody’s & S&P (BB+)).

The credit rating upgrade is of course good news and a significant step for Turkey, who has long sought to belong to the investment grade club. Moody’s has long been expected to sooner or later put Turkey firmly in investment grade, so the decision in itself is no huge surprise.

However, a credit rating upgrade, especially one that brings Turkey over the critical threshold of having two out of three ratings in investment grade, raises expectations of further capital inflows, both as portfolio and direct investments. This puts further strengthening pressure on the TRY and more pressure on the CBRT to control it. Thus Moody’s decision complicates the central bank’s efforts to keep the lira from strengthening.

This is of course only a problem as long as the CBRT is anti-TRY. An economic recovery, a pick-up in export demand from Europe and accelerating inflation would do a lot to turn the CBRT friendlier towards a strengthening lira. As we are expecting the economy to pick up, we are also projecting a TRY strengthening against both the dollar and the euro over the next two years.

In the mean-time, we continue to watch the real effective exchange rate of the lira, which will indicate the drive for further monetary easing, together with credit growth, inflation and economic growth. Especially after the rating upgrade, the central bank remains vigilant and ready to cut rates as well as hike e.g. FX reserve coefficients and ROCs.

We as previously see mid-term target for the rouble higher at 32 versus UD dollar, but as always exporters will play against this target. Taking into account potential for EUR depreciation rouble basket may stay near higher edge of CBR do-nothing zone 35.65. Past few sessions CBR didn’t intervene.

Interbank rates and swap rates stayed at high levels. The tension is very high on the Money Market. Current situation is may be harbinger of negative signal – the end of May will be very tough for the market participants. From the one side CBR is preparing for more dovish policy, however from the other side we see that regulator is very reluctant to extinguish the fire on the money market with extra liquidity. So basically expectations are the same – CBR will cut interest rates during coming months but the liquidity situation will likely remain tight.

3 month continue to have potential to go lower in the long run, staying stable in the short term.

• No need for Norges Bank to change view based on today’s figures.

GDP growth in Mainland Norway was 0.7% q/q in Q1. Our forecast was 0.7% while consensus and Norges Bank was 0.8%. Growth in Q4 was 0.2% q/q, marginally revised down from 0.3 %.

The main picture was broadly as we had expected. Consumption of goods rebounded strongly in Q1 pulling up the retail sector. Apart from this production growth was moderately good in the rest of the service sectors and on average in good production.

Production of electricity however decreased and pulled down growth by 0.1% point. That was a surprise to us and possibly also to Norges Bank. In that case “underlying” mainland growth which excludes electricity production was as expected by Norges Bank.

If one are to look for weaknesses in today’s figures it must be investments among the mainland firms which fell rather sharply after a drop also in Q4. It could be that this is an effect of tighter lending standards/increased lending margins from the banks the last years.

All in all today’s figures were only marginally below Norges Bank. The main conclusion on the last MPC meeting was that the real economy developed about as expected and today’s figures should confirm this.

Total GDP fell 0.2%, but this was no news as we had expected -0.1%. Total GDP growth has absolutely no influence on Norges Bank.

Q/Q growth in the mainland economy

The lion’s share of growth came from household consumption, which grew by a quarterly rate of 0.9% and contributed with 2.3%-points to growth. A government official said the GDP data showed consumers spent more on recreation, cars and dining out. Con-sumer confidence was generally lifted by expectations for higher wages and recent gains on the stock market. In addition, net exports were lifted by the weakest yen in 4½ years. The corporate sector remains cautious leading to a 0.7% fall in capital spending. The government is considering several measures to boost business investment.

The figures today are viewed as the first evaluation of Premier Shinzo Abe’s three arrow strategies to revive the economy. It is safe to say that he has received a high score. The positive surprise will keep the strong support of the Abe cabinet, currently more than 70%, and increase the likelihood for the LDP to secure a majority in the upper house election on 11 July. In a February survey, the LDP could count on receiving at least 42% of the votes, up from 37% previously.

• German growth (0.1%) was held back by an unusually cold winter but that’s doesn’t explain all the weakness. See more on this here.
• In France, an increase in government  consumption could not compensate for a small decline in private consumption and larger ones in capital spending and exports. Note, however, that France still looks much more robust than Italy and Spain.
• In Italy, GDP – in the longest recession on record – fell for the 7^th quarter in a row and is down by an accumulated 4% since the 2^nd quarter of 2011.
• Spanish GDP fell by 0.5%, with no details known for now.
• As a Euro core country in recession, the Netherlands are a very interesting case. The reported rise in private consumption over the quarter was the first since end-2011 (!). Given the weak housing and deteriorating labour market, the outlook for consumption remains cloudy. Fixed capital spending was down 11.6% over the year. It was foreign trade that prevented GDP from falling more than just 0.1% q/q in the first quarter.

Apart from Germany, Slovakia (0.3%) and Belgium (0.1%) were the only other Euro-area countries with positive q/q-readings. GDP was flat in Austria (see Eurostat’s press release here for more results).

The outlook: Bleak – this is the short version. Most sentiment indicators are pointing to declining GDP also in Q2. We still consider “some” recovery – meaning positive GDP q/q-readings – likely for the second half of this year. As an indication, a -0.2% reading in Q2, followed by +0.2 both in Q3 and Q4 would result in GDP declining by 0.7% y/y this year over last. Our current forecast for the full year 2013 is -0.4%, and we will revise that down shortly.

• Norges Bank would have to change its view significantly in case of another weak figure

It is often argued that the risk of financial imbalances is the main argument for not slashing key rates in Norway to zero with inflation far below the target. But if we are to believe Norges Bank, an output gap (potential mainland GDP minus actual) somewhat higher than zero and increasing is also an important factor. Key figures that indicate lower growth and lower capacity utilization could very well trigger a rate cut in June. And there is a clear downside risk to Norges Bank’s rather strong growth forecast. Growth slowed significantly in Q4. The labour market is not showing a clear picture, but there are at least some signs that this could have translated into a weaker labour market.

However, we believe Q4 was a temporarily weak spot and see strong reasons to believe in a rebound in Q1 mainland GDP which will be published on 16 May at 10.00. Retail sales have picked up strongly, pointing to a rebound in consumer-oriented sectors after a weak Q4. The few production indices we have (such as manufacturing) point in the same direction. We forecast a 0.7% q/q growth only marginally below Norges Bank and the consensus at 0.8%. In Q4 growth was 0.3%.

There is no reason to change view on Norges Bank if we are right, but if growth ends up say below 0.5% we will start thinking about a June cut again. There is no mechanic link between growth and the output gap and in the case of a weak figure we have to look into the details. Still, the picture of the economy is a bit blurred at the moment, so a weak figure could not only change the view on the current state of the economy but also on the outlook.