- CBRT decision a key moment for TRY outlook
- Failure to raise rates could send TRY lower
- Goldman Sachs says CBRT credibility on the line
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The British Pound could take a run higher against the Turkish Lira in the latter part of this week if the country's central bank fails to deliver an interest rate hike, according to a number of institutional analysts we follow.
The Central Bank of the Republic of Turkey (CBRT/TSCM) meets on 18 March to decide on possible changes in monetary policy, an event that has garnered more attention than would be typically expected given developments in global bond markets and the recent decline in value of the Turkish Lira.
The Lira had advanced against the U.S. Dollar for three successive months into January, but a reversal in fortunes in February and March (in which the currency has depreciated 1.50% already) means the currency has come back under pressure once more.
The decline in the value of the Lira will place pressure on authorities to act against further devaluation, or at least ensure any globally-lead decline is minimised.
The Pound-to-Lira exchange rate has advanced in an environment of Lira weakness: the pair recorded an all-time high on Nov. 06 2020 when GBP/TRY reached 11.27, but the pair subsequently fell lower amidst a broad-based recovery in emerging market currencies that swept the Lira higher.
Also aiding the Lira was a view that a newly-installed regime at the CBRT would take the necessary steps to help restore Turkey's financial position.
"Lira strength since TCMB personnel shifts in early November has, in large part, reflected the market giving policymakers credit for a more orthodox policy stance; if central bank credibility is perceived to have fallen, some of this credit may be withdrawn," says Sara Grut, an Emerging Market strategist at Goldman Sachs.
The Lira's recent weakness combined by Pound Sterling outperformance means GBP/TRY has recovered from a multi-month low at 9.6154, reached on Feb. 16, to trade back at 10.50.
Above: GBP to TRY price action since October 2020.
For those watching the Lira, Thursday's rate decision could be instrumental in determining how coming week's play out for Turkish exchange rates.
For the CBRT, it is time to deliver says Sébastien Barbé, Head of Emerging Market Research & Strategy at Crédit Agricole.
"The CBRT, under its new management, has repeated that it prioritises the fight against inflation and the rebuilding of FX reserves, and the monetary policy would reflect that," says Barbé. "The depreciation pressure exerted on the TRY against the backdrop of the global bond sell-off is a good opportunity to deliver."
Emerging Market currencies have come under pressure of late amidst rising bond yields in the U.S. and other developed economies. Rising yields are effectively a rising cost of finance for corporates and governments right across the spectrum and often Emerging Market countries and their currencies can be prone to stress in an environment of rising yields.
As yields have continued to rise pressures on the Lira have increased.
Crédit Agricole analysts tell clients for the CBRT the decision to cut can be seen against the backdrop of the cost-advantage analysis.
"The cost of hiking by, say, 100bp would actually be rather limited, since the 1W repo rate is already at 17.0% – the additional pressure on growth would be limited," says Barbé. "In terms of advantage, there is a clear incentive to hike rates further."
A rate cut would be a good way to strengthen the central bank’s credibility according to Crédit Agricole, who say the CBRT will not want to be perceived as being behind the curve and will instead want to demonstrate they can still do their job correctly.
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"We believe that the dangers of letting the TRY depreciate further without the help of a rate hike at this stage, would by far overcome the risk of an additional marginal constraint on economic growth," says Barbé.
Crédit Agricole look for the CBRT to hike the 1W repo rate by 100bp to 18.0% next week.
Goldman Sachs meanwhile says now is not the time for the central bank to sit on its hands as it could undo much of the progress taken by the new leadership to support the country's internal and external imbalances
Grut acknowledges that with real rates already high (policy rates significantly exceed inflation expectations in Turkey), there is some appeal to shy away from raising rates, but she argues to do so presents significant challenges.
Grut notes macroeconomic pressures have not yet appeared to be particularly responsive to higher real rates and inflation is likely to remain sticky this year.
The Goldman Sachs analyst adds Turkey’s current account deficit has been stubborn and - in contrast to the swings towards surplus among other EM high-yielders - appears likely to remain in deficit in 2021 amid rising oil prices and uncertain tourism inflows; and, with the Lira under renewed pressure, FX reserve buffers remain low (and have recently fallen).
She notes that market expectations of a hike have already been built up and as a result the Lira could be punished if this expectation is not met.
"If policymakers appear to under-deliver after signalling an openness to raising rates if needed, the potential impact on the Lira could be significant," says Grut.
Goldman Sachs expect the CBRT will deliver a 100bp hike.
Risks for Lira will be skewed to the downside should policymakers lean too-heavily on forward guidance and don't actually deliver, they warn.
Beyond the central bank's decision this week how the Lira trades over coming days and weeks will also rest with how global markets evolve, in particular the Emerging Market group of currencies.
"EM currencies have remained very much dependent on the gyration of US yields. We still believe that the correction which has driven down many EM currencies vs USD since the end of February will eventually lead to interesting levels to go long EMs, but the perspective of a further increase in US yields may postpone the time to re-enter EMs," says Barbé.
With this in mind, the key event for financial markets is this Federal Reserve (Fed) policy decision where investors will try to gauge whether or not the Fed intends to bring forward the time at which it will start winding back its quantitative easing programme.
Consensus is that Fed Chair Powell will send a strong message that the Fed will resist raising rates, an outcome that is on balance supportive of equity markets and emerging market currencies, such as the Turkish Lira.
Keep an eye on the Fed's own forecasts for future interest rates, known as the 'dot plot' chart: should the Fed signal interest rates rises in the future have become more likely then markets and the Lira could come under pressure.