Turkish Lira Draws Buyers as CBRT Decision Looms and Market Hopes for Policy Pivot

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The Lira advanced against major currencies on Friday having won new advocates within the analyst community ahead of next week's central bank interest rate decision, which the market hopes will bring a return to policy orthodoxy, potentially providing for an ongoing recovery of the fallen currency.

Turkey's Lira had risen by double-digit percentages against the Euro, Dollar and Pound for the week on Friday after new appointments to the finance ministry and Central Bank of the Republic of Turkey (CBRT) were followed by suggestions from President Recep Tayyip Erdogan that a change of interest rate policy could be on the horizon. 

In sometimes contradictory remarks President Erdogan appeared to indicate on Wednesday that he may no longer stand in the way of a return to an inflation targeting orthodoxy at the CBRT, which would mark a break with the unorthodox policy approach that has driven the Lira into the ground during recent years. 

"He was unusually specific in his comments to AKP lawmakers, saying that Turkey was determined to reduce risk and increase return for investors, and that it was the Central Bank’s task to form the policies that would reduce inflation," says Murat Unur, an economist at Goldman Sachs. "We expect the TCMB to raise the official policy rate from 10.25% to 15.00%. The upper bound of the interest rate corridor is already at 14.75% and the overnight interbank rate is at 14.9%. Hence, the 475bp hike we are forecasting would essentially mark the main policy rate (one week repo, currently not used) to the market, allowing the new leadership to gain credibility." 

President Erdogan said he wants to make Turkey "one of the top countries that will yield the highest and the most secure income when invested in," after replacing former finance minister and son-in-law Berat Albayrak with ex development minister Lufti Elvan after dismissing CBRT Governor Murat Uysal before appointing former finance minister Naci Agbal to post. 

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

Erdogan's comments and personnel changes have led markets to believe that he could be about to ease his perceived grip on CBRT policy decisions, enabling it to tackle high and rising inflation using conventional tools like interest rate rises. Until then and at least since early 2018 the Turkish leader had made the unorthodox assertion that rising interest rates produce higher inflation and vice versa while forcing the CBRT to cut its interest rate by more than half from July 2018 levels.

"President Erdogan has once again mentioned his theory on high rates causing high inflation, which seems to suggest to us that the green light may be temporary or the policy space given may be limited," Unur says. 

Politically inspired rate cuts saw the cash rate fall from 24% in July 2019 to just 8.25% by September 2020 when the CBRT suddenly hiked rates by a surprise 200 basis points to 10.25%, although this wasn't without investor angst first lifting USD/TRY and EUR/TRY more than 140% from January 2018 levels. 

Crippling currency devaluation has stoked even higher inflation and led the CBRT to burn through a large part of its foreign exchange reserves in a fruitless attempt to keep the Lira afloat, but this week's suggestion from Erdogan has raised hopes of a policy pivot among the Turkish leadership and institutions while drawing buyers to the Lira. 

"The departure of both the Finance Minister and the Governor of the Central Bank is perceived as a sign that the time has come for Turkey to adopt more conventional policies to slow capital outflows and stop the currency falling. They'll need to back up the talk with a significant rate hike next week if they want to avoid a very messy reaction by a market that has discounted it," says Kit Juckes, chief FX strategist at Societe Generale. 

The Lira outlook is hinged on the outcome of next Thursday's CBRT decision from which investors and analysts are looking to see a large increase in the main interest rate announced, likely taking it back above 15%. 

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

"Weekend developments and comments by Erdogan have reversed a dreadful upward trajectory in USDTRY. Despite the 9.4% rally vs USD since last Friday, we think the market remains skewed to short and underweight TRY positions. Therefore, we see scope for a rapid extension of the downside USDTRY move in the coming days, especially should the CBRT live up to expectations," says Cristian Maggio, head of emerging market strategy at TD Securities. "We enter a tactical short USDTRY position."

A large rate hike would be seen by the market as a commitment to returning to an inflation targeting orthodoxy, although one cannot be taken for granted because of past policy disappointments as well ambiguity and self-contradictions in some of this week's remarks made by President Erdogan and new finance minister Lufti Elvan. 

Elvan said Tuesday that "Turkey has a tradition of a market economy which functions according to rules. The important thing is to strengthen institutions, to operate the rules effectively. In this context, we will act with a consultation-based, participatory approach, taking the contribution of all interested parties," in his first address to parliamentarians as treasury minister.

This was after Erdogan effectively cast his contentious rate policy as a continuation of Turkey's war for independence, saying among other things 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 and first president of the republic. 

"The experience of the past several years has taught us that lira swings can be very sharp in either direction. But we think momentum is building and USDTRY could fall, under the right circumstances, to the low 7s," TD's Maggio says. "The main risk to our view is the CBRT will disappoint when it decides on rates next week (19 Nov). We expect a 575bps increase of the repo rate to 16%. Anything below could undermine the positive sentiment that is building and reverse the trend, with the 8 handle easily achievable."

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