Turkish Lira Steady as CBRT Test Looms but Erdogan's Latest Remarks Remind of Risks to Outlook 

Image © Paul Morigi Photography / Brookings Institute. Reproduced under CC Licensing

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The Lira was steady against major currencies on Wednesday even after reported remarks from President Recep Tayyip Erdogan that appeared to cast doubt over the country's interest rate outlook ahead of central bank meeting that is of the utmost importance to the outlook for the Turkish currency. 

Turkey's Lira was a fraction higher against a weakened Dollar on Wednesday but a touch softer relative to the Euro and Pound, with exchange rates having held remarkably stable throughout the session even after conspicuous remarks from President Erdogan.

Erdogan reportedly told the Turkish Union of Chambers and Commodity Exchanges (TOBB) Economy Council Meeting that investors should not be left to "get crushed under high interest [rates]," appearing to contradict the market's idea that Turkey is one the verge of a landmark shift in interest rate policy.

Erdogan was also reported to have said the government would solve upcoming Turkish problems "in accordance with the market economy rules," and that lowering inflation down to the single digits is a top priority. 

Above: USD/TRY, EUR/TRY (blue) and GBP/TRY (black) shown at hourly intervals.

The problem for the Lira is that Erdogan's ideas about how to lower inflation are precisely the opposite of those held by almost all other market economies, with the President having argued that higher interest rates lead to higher inflation and vice versa. 

The meaning and policy implications of the remarks are of significant importance given that Turkey's Lira rallied by more than 11% against major currencies last week based on the market perception that personel changes in key institutions mean a change of policy is afoot, which is since crystalised into an outright expectation on the part of investors who're now looking to see a large interest rate rise announced by the Central Bank of the Republic of Turkey (CBRT) on Thursday at 12:00 London time.

"There is considerable uncertainty around the meeting but our base case is a 300bp rate hike. This seems a minimum requirement to sustain the rally," says James McCormick, global head of desk strategy at Natwest Markets. "EM currency crises almost always reach that moment where markets are at maximum bearishness and policymakers are forced to deliver sizable rate hikes to stabilize the currency. Turkey is now at that juncture. A return to more policy orthodoxy would put a floor on currency weakness. Eventually the attractiveness of much higher carry would lure investors back. Next week will be a big test."

The Lira is up by a double-digit percentage against the Dollar and Euro for the recent week but previously Erdogan's unorthodox inflation strategy and perceived undue control over the central bank had lifted USD/TRY and EUR/TRY more than 140% from January 2018 levels. The Lira has been crushed by Erdogan's rate policy, wtih depreciation itself further lifting inflation and damaging the economy in the processs.

However, last week's ousting of CBRT Governor Murat Uysal and finance minister Berat Albayrak has led investors to believe the government could be about to u-turn. 

Above: USD/TRY, EUR/TRY (blue) and GBP/TRY (black) shown at daily intervals.

"Foreign outflows have been significant, and Turkish assets are underowned relative to recent history. A rate hike and a commitment to stabilising inflation could see some inflows initially, but confirmation that policy will move towards a more orthodox setting may be needed to unlock larger and longer-term inflows," says Galvin Chia, a Natwest colleague of McCormick's. "We are more circumspect in the medium term – while recent statements and speeches show initial momentum towards market-friendly policy, committing to and delivering on policy to bring down inflation and address external imbalances in the medium term is the second, and more difficult, policy test."

Comments by replacement central bank head Naci Agbal and finance minister Lufti Elvan last weel also encouraged the market view that a large rate hike and sustained change in policy is on the horizon, although Erdogan has and does continue to blow hot and cold. With Wednesday's remarks aside, he said last week amid all of the market excitement about a policy pivot  that “We are now waging a struggle of historic importance against those who seek to yet again condemn Turkey to modern-day capitulations through the shackles of interest rates, exchange rates and inflation" when celebrating the memory of Ghazi Mustafa Kemal Atatürk, founder of the Turkish republic. 

At stake this week is a Lira rally that if allowed to endure, could reverse a long-term technical trend of depreciation for the Turkish unit. The market consensus is for a +475 basis point interest rate rise this Thursday, which many analysts and economists expect to come alongside assurances that further hikes will follow any additional increases in inflation. The CBRT lifted its cash rate 200 basis points to 10.25% in September, although the rate itself is still down from the 24% that prevailed until July 2019.

"The Turkish Lira has reversed. EUR/TRY formed a major top at 10.1969 and now targets the 8.8229/8.7517 support zone," says Axel Rudolph, a senior technical analyst at Commerzbank. "USD/TRY formed a major top at its recent all-time high at 8.5814 (according to CQG data) before swiftly coming off towards the late September low and the 2020 uptrend line at 7.4945/4639. In this area the cross is likely to short-term stabilise."

Above: USD/TRY, EUR/TRY (blue) and GBP/TRY (black) shown at weekly intervals.


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