Turkey’s lira tumbled to its lowest level against the dollar as interventions by state banks failed to keep a lid on the currency’s depreciation.
At the root of the strains are concerns about the level of Turkey’s reserves and an aggressive monetary easing cycle that’s fuelled an outflow of foreign capital. With pressure mounting on the currency, authorities have been leaning on state banks to bolster the lira with dollar sales, rather than raising interest rates or curbing the supply of credit.
The central bank has delivered 1 575 basis points of interest-rate cuts in nine consecutive steps since July 2019, driving borrowing costs adjusted for inflation below zero. Meanwhile, state lenders channeled credit stimulus across the economy and policy makers injected liquidity by scooping up government bonds.
Officials will likely use other tools before resorting to an interest-rate hike, such as imposing “strict limits” on dollar purchases for Turkish residents, or substantially raising taxes on these transactions, said Piotr Matys, a strategist at Rabobank in London.
“Raising interest rates substantially would be an admission that the strategy — of cutting interest rates well below levels that would be justified by the outlook for inflation and offsetting real negative interest rates with costly FX interventions — has failed.”
The lira fell as much as 3.2% on Thursday to 7.2775, and traded at 7.2270 versus the US currency as of 2:40 p.m. in Istanbul, leading declines in emerging markets. The cost of insuring the nation’s bonds against default climbed to the highest in three months, while the main stock gauge lost 3.2%, making it the worst performer among developing-nation peers.
In the view of analysts from Goldman Sachs Group and Oxford Economics, rate increases may be warranted soon. Others are less bearish, citing a shortage of liquidity in the offshore money-market engineered by authorities.
The cost of overnight funding spiked to over 1 000% earlier this week, making it prohibitively expensive for foreign investors to borrow the currency and bet against it.
“My sense is that there is more tolerance for currency volatility than there is for a drastic measure like an emergency rate hike,” said Phoenix Kalen, a strategist at Societe Generale in London. “And with the squeezes in the front-end rates, market participants are, needless to say, wary about getting burned trying to short the lira speculatively.”
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