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Falling lira and high prices put Turkey in tight spot

November 4, 2020

An equally surprising decision to hold rates steady last month only added to investors’ concerns

ISTANBUL: A currency that has tumbled nine straight days to record lows and inflation stuck in double-digits are giving Turkey’s central bank little option but to hike interest rates again even if it trips up an economic recovery just gathering pace, analysts say.

Data on Tuesday showed that a 30 percent slide this year in the lira — the worst in emerging markets — had a big hand in keeping annual consumer price rises near 12 percent last month, well above the bank’s target range around 5 percent.

A surprise interest rate hike in September has done little to halt a currency depreciation driven by concerns over possible Western sanctions against Ankara, depleted foreign exchange reserves and negative real interest rates.

An equally surprising decision to hold rates steady last month only added to investors’ concerns that the central bank may be swayed by overt pressure from President Tayyip Erdogan’s government for monetary stimulus in the face of the pandemic. With manufacturing and trade activity picking up steam, Governor Murat Uysal said last week the bank needed to retain some flexibility even while he raised inflation forecasts and kept the door open to hiking rates.

Economists and investors say that flexibility is disappearing after the lira on Tuesday slid another 1 percent beyond 8.5 versus the dollar for the first time.

“There is really no good option for Turkey at the moment,” said Gilles Moec, of AXA Group.

“Either they accept a slide in their currency which has implications for stability,” including Turks converting savings into dollars and companies struggling to pay dollar-denominated debts, he said. “Or they have to go much, much further in their monetary policy tightening which hits the economy.”

Adding to risks for an economy leaving behind a near 10 percent contraction in the second quarter, the US presidential vote could strain bilateral ties if Joe Biden, the Democratic candidate and front-runner, wins on Tuesday. Societe Generale expects the lira to hit 9 versus the dollar by year end.

The last Reuters poll of 15 economists forecast the policy rate, now 10.25 percent, would rise to 12.25 percent by year end, though some see it higher, such as Goldman Sachs, which expects a hike to 17 percent.

The lira has fallen more than 8 percent in less than two weeks since the central bank held policy steady and instead lifted the late liquidity window (LLW), the top limit of the interest rate corridor, to 14.75 percent. So-called back-door policy moves helped to tighten money supply and pulled the average cost of funding up to 13.45 percent as of Monday, from 7.4 percent in July.

Erdogan said on Saturday that Turkey is waging an economic war against “the devil’s triangle of interest and exchange rates and inflation.” Yet inter-bank money markets have been raising the odds of a formal policy tightening and on Tuesday the rate to borrow for a week was nearing 16 percent, well above the LLW.