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Turkish Lira’s Troubles Ease after CBRT Rate Hike but Faces A Long Walk Out of the Dollar’s Woods 

-TRY rally endures following CBRT rate hike, change to FX rules.
-CBRT interest rate lifted to 10.25%, placing floor under the TRY.
-Analysts, economists say losses will resume without more hikes.

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  • GBP/TRY spot rate at time of writing: 9.6666
  • Bank transfer rate (indicative guide): 9.3283-9.3959
  • FX specialist providers (indicative guide): 9.5216-9.5796
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The Lira rallied further on Friday after regulators relaxed restrictions on currency transactions following a surprise interest rate rise from the central bank, although analysts say the road toward stability is a long one and that rate setters will need to go further to prevent fresh losses befalling the Lira.

Turkey’s Lira advanced against the Dollar, Pound and Euro Friday amid an ongoing rally that was ignited in the previous session when the Central Bank of the Republic of Turkey (CBRT) lifted its main interest rate from 8.25% to 10.25% in a decision that took investors by surprise. 

“The easing of restrictions on lending lira abroad will help ease liquidity concerns and is another short-term positive that is helping TRY advance further this morning,” says Derek Halpenny, head of research, global markets EMEA and international securities at MUFG. “The broad conditions in the markets and general USD sentiment will also be important. Further bouts of elevated risk aversion could see TRY depreciation resume. But this action is at least good news over the short-term.” 

The CBRT’s rate hike was followed by a Banking Regulation and Supervision Agency decision to ease restrictions on domestic lenders foreign exchange derivative transactions with foreign entities, enabling them greater quantities of Lira to international markets in return for short-term supplies of foreign currencies and vice versa. Local lenders will now be able to carry out twice the amount of business in FX ‘forward,’ ‘swap’ and ‘options’ markets. 

Above: GBP/TRY rate shown at 15-minute intervals.

The decision enables commercial banks, which have acted somewhat like a front for the official authorities in recent years, to build foreign currency liabilities and receivables in greater quantity for up to one year ahead.

But the Lira rally resulting from this and Thursday’s rate hike could prove to be just a flash in the pan if either the decision is reversed, or not followed up in the coming months with further increases. 

“We think that it will fall back before long unless the central bank follows up today’s decision with more rate hikes,” says Franziska Palmas at Capital Economics, of the Lira. “For one, the fundamental drivers of the lira’s depreciation this year have not gone away. Turkey’s current account deficit has widened sharply, as the pandemic has severely damaged the country’s key tourism sector. Its external hard currency liabilities, built up over a decade long credit boom, remain very high.”

Turkey is thought to have an inflation problem after years of rapid, debt-funded growth was met by interest rates the market deems to be inadequate.

Price pressures have also resulted from the market’s perception that the country also has a governance problem, given President Recep Tayyip Erdogan’s rhetorical complaints about high rates and fact that Turkish monetary authorities have frequently reduced borrowing costs in the wake of complaint from the elected leader, and even at times when inflation pressures were rising. 

Above: USD/TRY rate shown at daily intervals.

There’s little to tell how much of Turkey’s inflation problem results from an ‘overheating’ economy and how much from chronic currency depreciation that comes with market protests about official and unofficial policy.

However, rising inflation typically begets higher interest rates, somewhat idled capital and slower economic growth in the modern world where most central banks are working to an “inflation targeting” mandate, and slower growth is the opposite of what Turkey’s leadership promised to the electorate.

“This is certainly a bold step in the face of calls by President Tayyip Erdogan to keep rates low. The exchange rate has reacted positively to the move, but only modestly, reflecting probably the purging out of existing short positions. In order for the hike to have a more discernible medium-term impact, though, the market would have to be convinced that CBT can launch a sustained hiking cycle,” says Tatha Ghose, an analyst at Commerzbank. “Otherwise why should this hike be any different from the many emergency one-off hikes which preceded it?” 

The market’s inflation orthodoxy has been thrown to the wind in Turkey during recent years, with rising prices often prompting even lower interest rates - followed by steep, punishing falls for the Lira, raised import costs and yet further increases in consumer prices.

Turkey’s cash rate has been cut from 24% in July 2019 to 8.25% until Thursday.

Above: Tradingeconomics graphs showing Turkish interest rate (top , centre) and Turkish inflation rates.

In the same time however, the main and core inflation rates have also fallen from above 20% to below 10% in early 2020 before beginning to rise again as the year has unfolded. Meanwhile, USD/TRY had risen 10.38% for 2020 on Friday while the import-and-export-important EUR/TRY was up 14.6%, with both denoting a large policy and pandemic-related depreciation of the Lira.

What matters most for the Lira now is whether the CBRT follows up with further rate hikes, as well as what happens with inflation and global market conditions in the interim. Failure to follow up could further cultivate market suspicions that Turkey’s central bank is under the control of the government and trigger a fresh and somewhat self-perpetuating cycle of currency depreciation where Lira falls lift inflation and then demand further depreciation so as to prevent ‘real’ or inflation adjusted exchange rates from rising

“Efforts by the CBRT to steady the lira earlier in the year have heavily depleted the central bank’s foreign exchange reserves. What’s more, Turkey’s high level of inflation – the headline rate reached 11.8% in August – means that the nominal exchange rate needs to depreciate to prevent the real exchange rate from appreciating,” says Capital Economics’ Palmas. “The central bank’s reluctance to raise interest rates until now appeared to stem from President Erdogan’s aversion to interest rates hikes. It is not clear yet if he approves of today’s hike. To convince investors that it is serious about tackling high inflation, we think the central bank would have to raise interest rates further over the coming months and then keep them positive in real terms for a prolonged period. We are not convinced that that will happen, given past experience."

Capital Economics forecasts the USD/TRY will rise to 9.25 by the end of 2021, implying a greater-than 20% depreciation for the Lira over the next 15 months. Such a decline would be reflected with similar moves in other Turkish exchange rates where the opposing currencies are able to avoid equivalent depreciation relative to the Dollar. 

Above: GBP/TRY, USD/TRY (orange line, left axis) and EUR/TRY (black line, left axis). 


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