Turkish Lira Forecast Upgrades Loom after CBRT Steers TRY Back onto Recovery Road

Image © Central Bank of the Republic of Turkey, CBRT. Governor Naci Ağbal.

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The Lira turned back onto recovery road leading GBP/TRY, USD/TRY and EUR/TRY to topple on Thursday after the Central Bank of the Republic of Turkey (CBRT) more-than met expectations with its latest interest rise, prompting some analysts to suggest forecast upgrades are on the way.

Turkey's Lira turned higher and notched up sharp gains over all major rivals in developed and emerging markets on Thursday after the CBRT lifted its cash rate 200 basis points to 19% and its higest level since 2019, surprising on the upside of market expectations for one percent increase. 

A 100 basis point increase was said by analysts to be the minimum necessary for the CBRT to generate the currency appreciation necessary for Turkey to meet the bank's target of bringing down inflation to 9.4% by year-end, a key milestone in a longer-term bid to reduce inflation to 5% in 2023. 

"Domestic demand conditions, cumulative cost effects, in particular the exchange rate effects, increasing international food and other commodity prices and high levels of inflation expectations continue to affect the pricing behavior and inflation outlook adversely. On the other hand, supply constraints intensifying in some sectors and the adjustments in wages and administered prices maintain their importance," the Bank's statement says. "Considering the upside risks to inflation expectations, pricing behavior and the medium-term inflation outlook associated with these developments, the MPC has decided to implement a front-loaded and strong additional monetary tightening."

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

Governor Naci Ağbal and colleagues more-than delivered on expectations, citing among other things global inflation expectations that "lead to uncertainties about advanced economy monetary policies, and volatility in global financial markets," which had blown the Lira off its earlier recovery path of late. 

The Lira's reversing uptrend and strong economic growth at home in Turkey had posed an upward threat to the CBRT's inflation objectives.

On the international scene accelerating vaccination programmes have been stoking expectations of robust economic recoveries in the U.S. and parts of Europe, expectations which are bolstered by abnormally high levels of ongoing government spending as a result of the coronavirus crisis.

These factors have had investors questioning if the Federal Reserve will really hold its Fed Funds rate at the effective lower bound even as U.S. inflation exceeds its target in the coming months, if-not years.

The market is perhaps yet to take the Fed at its word on this.

Above: USD/TRY at daily intervals with 10-year U.S. government bond yield (green) & 10-year Turkish yield (purple).

Rising expectations for U.S. growth, inflation and interest rates are feeding increases in bond yields that taken wind from the sails of even higher-yielding emerging market currencies this year. The latter were popular in 2020 when the Fed first adopted its new "average inflation targeting" strategy, which is the source of its ambition to keep U.S. rates near zero for years yet and a risk to the U.S. Dollar in the months ahead; especially as investors are also betting rates will rise in other advanced economies too.

"It is crucial that the lira offers a sufficiently attractive carry trade to appreciate in the coming months, or at the bare minimum to be relatively stable against the dollar," says Micheal Every, a global strategist at Rabobank.

USD/TRY tumbled as the Lira strengthened against the Dollar following Thursday's decision, making Turkey's unit one of only a small handful of currencies to have advanged against the Dollar on the intraday basis. The Dollar was almost universally higher alongside U.S. bond yields as Wednesday's Federal Reserve-induced sell-off reversed.

Broad strength in the Dollar and Lira combined was enough to ensure that GBP/TRY and EUR/TRY losses were even steeper than those seen in USD/TRY, although all could see further downside in the weeks ahead if investors come to consider the Lira's interest rate offering sufficiently improved. 

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

The Pound-to-Lira exchange rate was toppling toward the round number of 10 on Thursday but would fall at least as far as 9.94 if TD Securities' soon-to-be-upgraded forecast of a 7.15 USD/TRY rate by month end is right and GBP/USD fails to make much progress from Thursday's 1.39 in that time.

"The tighter policy environment can help offset part or the whole of the weakness introduced in recent weeks by higher US rates, a side risk that remains material for TRY and other EM currencies," says Izidor Flajsman, an emerging market strategist at TD Securities. "We will likely deliver a revision to our USDTRY forecast in order to incorporate more lira strength than currently anticipated. As far as today's decision is concerned, the lira is now moving back to closer to our endQ1 forecast of 7.15." 

GBP/TRY always closely reflects relative moves in USD/TRY and GBP/USD.

The Pound-to-Lira rate would likely fall even further than 9.94 if TD Securities lowers its USD/TRY forecast and the envisaged outcome is realised. 

Likewise for EUR/TRY, which would fall to 8.51 in any market where USD/TRY trades down to 7.15, unless Euro-Dollar is able to lift off from Thursday's 1.19.