GRAPHIC-Going up? Five questions for Turkey's central bank

By Marc Jones and Jonathan Spicer

ISTANBUL, March 17 (Reuters) - Turkey's central bank on Thursday faces the biggest test of its hard-won credibility under new governor, Naci Agbal: will it turn hawkish words into action and raise interest rates as nearly all analysts expect, or hold them steady?

At 17%, Turkey's policy rate is already the highest of any large economy, and President Tayyip Erdogan has made no secret he wants cuts soon to help the economy rebound from the coronavirus pandemic.

But inflation, at nearly 16%, has edged higher than expected and the global bond market rout hit the lira hard this month. In turn, pressure has quickly mounted on the bank to hike rates by 100 basis points to 18%.

Here are five key questions on the radar:

1. WILL THE BANK HIKE?

Annual inflation is up to mid-2019 levels and has been mostly in double digits for four years. The lira TRYTOM=D3 fell 10% in the last month, halting a rally and adding more inflationary pressure in import-dependent Turkey. nL8N2LA1GU

Nearly all economists polled by Reuters expect a hike to 18% in the policy rate TRINT=ECI. Given that rising global yields are squeezing all emerging markets, Agbal - who was appointed by Erdogan in November - has little room for error. nL8N2LA2OZ

"The most important thing is to meet or exceed market expectations," said John Floyd, head of macro strategies at Record Currency Management.

"The more they can make positive strides, the more they can insulate themselves" from global market volatility, he added.

2. CAN THE BANK HIKE?

When Erdogan appointed Agbal he acknowledged that even "bitter" policies would be needed to lower inflation and he repeated that aim last week.

Yet the president abruptly fired the last two central bank chiefs and holds the unorthodox view that high rates cause inflation, raising questions over monetary independence in recent years. nL8N2KL3FN

Even if Agbal tightens on Thursday, he may soon need to do more: rising energy prices should lift inflation for another couple of months, and some market measures predict rates rising higher than 18% before declining later in the year.

Investors "want reassurance about political interference in monetary policy," said Kieran Curtis at fund manager Aberdeen Standard Life. "A hike would underline what we think we heard from Erdogan last week - that the fight against inflation is still the number one priority." nL8N2LE23T

3. WHAT ELSE IS SAPPING CREDIBILITY?

The central bank's badly depleted FX reserves has worried investors over the last two years, driving foreign outflows. On a net basis the buffer fell by three quarters last year alone, leaving Turkey more vulnerable to financial crises.

A policy of state bank interventions to prop up the lira, totalling some $130 billion in dollar sales since 2019, propelled the decline.

Agbal has promised to rebuild the buffer, and his more orthodox approach has reversed the tide of foreign funds.

4. WILL TURKS REGAIN FAITH IN LIRA?

The lira's decades-long fall has turned Turks to dollars, euros and gold, especially with inflation raising living costs.

Negative real rates a year ago reinforced local distrust, though last year's monetary tightening pushed those into positive territory.

Local holdings of hard currencies including gold hit a record $236 billion last month but have since eased.

Enver Erkan, economist at Tera Yatirim, said a turnaround would only happen if inflation drops or real returns on lira deposits rise in a sustained way.

"Locals must be in a position to believe that the lira will gain value. It will take time," Erkan said.

5. WHAT ARE THE SCENARIOS IF RATES RISE - OR DON'T?

Analysts say a 100-point rate hike would address recent market volatility and reinforce the credibility Agbal earned in tightening policy to 17% from 10.25% in November and December.

If the bank bucks expectations and holds policy steady, they say Agbal risks falling behind the curve and remaining at the mercy of global markets amid a rebound from the pandemic.

"As we move into further distribution of the vaccine and the summer tourism season, it is an opportunity for Turkey to stand out," said Floyd of Record.

Inflation is still within the central bank's forecast range. But if the lira takes another dive, inflation forecasts - including that of the bank - will likely be upgraded.

"We are entering a period in which inflation risks increase with ... the potential of volatility and depreciation in the lira to trigger additional inflation risks," said Tera's Erkan.

"If the market expectation is not met, lira volatility may increase."

(Additional reporting by Canan Sevgili, Ali Kucukgocmen and Nevzat Devranoglu;
Editing by Bernadette Baum)

((marc.jones@thomsonreuters.com; +44 (0)20 7513 4042; Reuters Messaging: marc.jones.thomsonreuters.com@reuters.net Twitter @marcjonesrtrs))