Tue Jul 30, 2013 6:31am EDT
* Cbank hikes 2013, 2014 inflation forecasts
* Lira stability a priority, but no set level
* Main policy rate set to stay on hold
* Further adjustments to rate corridor on agenda
By Asli Kandemir
ANKARA, July 30 (Reuters) - Turkey's central bank raised its inflation forecasts for this year and next on Tuesday, saying lira volatility posed a threat to prices, and signalled further interest rate rises.
In an unusually frank assessment of the bank's policy direction, Governor Erdem Basci said the main one-week repo policy rate would likely be kept on hold at 4.5 percent for a "long time".
But he said the interest rate corridor around that rate - the lending rate at the top and the borrowing rate, currently at 3.5 percent, at the bottom - would continue to be adjusted.
The bank hiked its mid-point inflation forecast for the end of 2013 to 6.2 percent from a previous 5.3 percent, and for the end of 2014 to 5 percent from 4.9 percent. It also said growth may undershoot an official forecast of 4 percent for this year.
At a news conference announcing its quarterly inflation report, Basci said core inflation was expected to rise due to exchange rate volatility. But while maintaining a stable lira was a priority, he said there was no set limit at which it would defend the local currency.
"We no longer need to hold forex-selling auctions. We are continuing with adjustments on the interest rate corridor, and we will be more flexible if necessary. We can sell forex on very stressful days," Basci said.
"The central bank will not defend a specific lira level."
The bank raised its overnight lending rate by 75 basis points to 7.25 percent a week ago in response to capital outflows that have knocked the lira down as much as 9 percent against the dollar over the past few months.
Basci said that move had been enough for now but that there would be further tightening.
He said the bank was not currently planning to make adjustments to the reserve requirements or reserve option coefficients it uses to fine tune liquidity conditions.
Markets were largely unmoved by the comments, with the lira slightly weaker at 1.9269 to the dollar than late on Monday and the yield on Turkey's 10-year bond <tTR080323TVA=IS > steady at 9.43 percent.
"I guess the message is that the central bank is not overly concerned by recent lira weakness, but (it is) classic central bank speak," said Timothy Ash, head of emerging markets research at Standard Bank.
"It is not the level but the pace of change in the currency/volatility that the central bank is concerned by."
RISKS TO GROWTH
Uncertainty over the continuation of the U.S. Federal Reserve's bond-buying programme has hit emerging markets in general, but Turkey has also been shaken by demonstrations last month against Prime Minister Tayyip Erdogan's government.
Erdogan has long championed low interest rates, fearing an economic slowdown ahead of elections beginning next year.
But the central bank has already burned through more than $6.8 billion, or about 15 percent of estimated disposable reserves, this year to try to defend the lira without raising rates, a policy which has had limited success.
Last week's rate hike came days after Erdogan met with senior members of his economic team, prompting suggestions that Basci had only acted after a government nod. But Basci asserted the bank's independence on Tuesday, saying it received approval only from monetary policy committee members before acting.
The government is targeting growth of 4 percent this year, a significant acceleration from last year's 2.2 percent gain but well below the 8.8 percent expansion of 2011, which was Europe's best. In the first quarter the economy grew 3 percent.
Finance Minister Mehmet Simsek said last week he saw risks to growth and inflation targets this year from external factors including energy prices and the health of the euro zone economy, while Deputy Prime Minister Ali Babacan has said it should be "no surprise" if the government revises down its growth outlook.
Basci said he expected loan growth still to be running at significantly above the bank's 15 percent reference level at the end of the year, but forecast it would fall to around target in the middle of 2014.
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