Pound-to-Lira Rate: Where Next?

A diplomatic crisis between the Turkish and US authorities has shaved several percentage points off the already weak Lira but despite the severity of the dispute most analysts expect a cordial conclusion and the currency weakness as only temporary.  

The Lira weakened sharply versus the Pound - and most other currencies - after strained diplomatic relations between the US and Turkey came to a dramatic head, on Monday.

The resulting spat sent the Lira into a steep nosedive, losing over 6.0% against the Dollar but also a substantial amount versus the Pound which went from being able to buy 4.72 Turkish Lira on Monday morning, to buying 4.93 at the peak of the day's volatile trading.

The sell-off was caused by the US embassy's decision to stop issuing visas to Turkish citizens for travel to the US.

This came after one of its employees (Turkish born) was kidnapped by Turkish authorities claiming he had links with Fethullah Gulen, a moderate Islamist cleric, who is wanted in Turkey for allegedly conspiring against the state.

Tensions already existed between the US and Turkey as the US has repeatedly resisted Turkish attempts to extradite Gulen, who lives on US soil in Pennsylvania, on the basis that the Turkish state cannot provide sufficient evidence of his involvement in terrorism. 

Some commentators think Turkey's kidnapping of US Embassy staff is an attempt to gain leverage or barganing 'chips' in the hope for a custody swap deal with Gulen.

The Turkish embassy in Washington also suspended the issuing of any new visas.

However, most analysts see the weakness as only a temporary derogation which will 'right' itself eventually.

The Lira has already recovered quite a substantial share of the loses it endured on Monday.

"The TRY is recovering some further ground after yesterday’s flash-crash and we do not see this visa incident as a start of a major deterioration in US: Turkey relations," said ING Bank N.V.'s, Head of Foreign Exchange Strategy, Chris Turner, in London.

"Firstly it is nowhere near as severe as Turkey’s shooting down of a Russian plane in November 2015, which after Russian sanctions saw a de-escalation by the following June," he adds.

"Secondly this reciprocal visa ban seems to have taken place more at embassy than at State Department/Foreign Ministry level, suggesting a less severe form of dispute," says Turner.

Both countries are also members of NATO - another reason to expect them to calm down.

Positioning in Turkish assets is not particularly high so there is unlikely to be a huge amount of fallout from the incident.

Nevertheless, the general backdrop has not been particularly supportive for the Lira, so despite analysts expecting the incident to blow over and the Lira to recover, the tide remains against the currency.

A note from brokers LGT reminds us that the Lira was struggling even before the most recent touchpoint due to rising US rates which can weigh on emerging market currencies but especially TRY.

Higher US rates can hurt EM's like Turkey which has a lot of Dollar-denominated or US-originated debt as the higher rates increase repayments and the strengthening Dollar can also make those repayments more expensive.

"While the Turkish lira was under pressure over recent days as the country’s currency was adjusting to further rate hikes in the US as well as the prospect of the Fed balance sheet unwinding, the recent events are reminding investors that political events pose a risk to EM asset prices," said LGT. 

Pound-to-Lire Exchange Rate Outlook: What the Charts say

The two views: that the current bout of weakness due to diplomatic tensions will blow over and that the Lira is vulnerable to rising US rates is reflected in the long and short-term charts of GBP/TRY.

The monthly chart below shows how the pair has been in a long-term uptrend but the 4-hour chart shows the massive gap which opened yesterday after the diplomatic meltdown.

One thing we know about gaps is that they have a tendency to fill, and so we would naturally expect this gap to fill too.

Therefore a break below the level of the upper part of the gap at 4.8220 would probably lead to the gap filling up, and a move down to the lower end of the gap at 4.7260.

There is also the possibility that this gap higher represents an exhaustion move in the longer-term trend, which itself could be at risk of a reversal, although it is too early to determine that with more certainty.

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