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Lira crash: is the mega interest rate hike coming now?

D.he analysts’ comments on the Turkish national currency, the lira, sound increasingly fatalistic: “Everything is possible now,” writes Sebastian Petric, Turkey expert at Raiffeisenbank International (RBI), on Wednesday. In order to avoid a repetition of the currency problems of 2018, the central bank should have “acted decisively” last week. But it left interest rates largely where they were. Tatha Ghose from Commerzbank sees “no reason why the dollar-lira exchange rate could not exceed the 9.00 mark in the coming weeks or months.”

By the middle of the week he had already crawled a bit in this direction and added another to the negative records that were meanwhile daily: while the dollar cost 8.20 lira early in the morning, it hit the 8.30 lira mark later in the morning. In euros, things didn’t look any better for the Turkish currency: 9.77 lira had to be paid for the euro. It was still available in March for 7 and in July for 8 lira. The euro-lira rate is now moving towards 10 lira.

The new inflation forecast that the Turkish central bank announced on Wednesday did not prevent him. According to Governor Murat Uysal, she now expects an annual average inflation rate of 12.1 percent. This is 3.2 percentage points more than the officially expected 8.9 percent so far. In the coming year, the rate of inflation, which is an important determinant of monetary policy, is expected to be 9.4 percent. So far, the central bank had put it at 6.4 percent. Higher import costs as well as rising food prices and credit growth have meant that inflation has not come down as much as expected, he said.

“The central bank is catching up with market developments and reality,” commented Christian Wietoska from Deutsche Bank. The unexpected announcement of the inflation forecast is also a reaction to the weakness of the lira.

However, central bank chief Uysal defended the bank’s decision from the previous week, which accelerated the lira’s slide, to leave the key interest rate unchanged at 10.25 percent and only to raise the interest rate for other liquidity aids. The reason for keeping the most important interest rate for one-week money market transactions stable is the global uncertainty caused by the Covid-19 pandemic.

Suddenly on the hawkish side

In general, the decision was seen as evidence that the central bank was still under the influence of the presidential palace and could not act freely. Perhaps Uysal wanted to counteract that with the appearance in Istanbul.

Nonetheless, German banker Wietoska interprets the statements as a “big shift” and suddenly sees Uysal “on the hawkish side compared to what we expected of them”. These forecasts are now much closer to market expectations.

As much as he criticized the interest rate decision of the previous weeks as a “wasted opportunity”, he now estimates “the likelihood of a more aggressive monetary policy reaction by the central bank in the near future”. Such an emergency rate hike will probably be less blatant than in the crisis year 2018, i.e. the central bank raised the key interest rate from 17.25 to 24 percent: “We see the possibility of increasing the rate for the one-week report rate by 475 basis points to 15 percent” said Wietoska.

VTB Personal-Financial.com analyst Akin Tuzun also expects a significant rate hike in November; “The pressure on inflation and the lira is likely to force the Turkish central bank to act more conventionally.” Commerzbank expert Ghose is preparing for a sharp rise in the key interest rate: “After the experience of 2018 it is also clear that a major emergency A rate hike is not a credible long-term policy response. Still, an emergency rate hike similar to what it was then could be the most likely attempt to break the devaluation dynamic. “

The lira does not only suffer from financial and economic policy decisions. A large number of foreign policy conflicts – Caucasus, Syria, Iraq, Libya – are increasingly affecting Turkey’s relationship with its most important trading partners in the EU and America. There is a threat of sanctions, American ones because of the Russian S-400 missile defense system, which NATO partner Turkey tested last week despite warnings, and European ones because Turkey is still looking for gas in areas of the Mediterranean that other countries claim for themselves. The exchange of blows with French President Emanuel Macron over Mohammed caricatures and his criticism of Islam is now added – although President Recep Tayyip Erdogan’s call to boycott French products also hits the Turkish economy, which builds French cars under license for export .

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