The Lira was crushed early in the new week with losses rivaling those seen by Pound Sterling following the Brexit referendum after another Central Bank of the Republic of Turkey (CBRT) Governor was shown the door an apparent political response to last week’s interest rate rise.
Lira Loses to Dollar, Euro, and British Pound
Turkey’s Lira collapsed more than 17% against the Dollar, Euro, and Pound at its lowest ebb and within an hour of Asia open on Sunday, taking it back to within arm’s reach of record lows seen last year before the appointment of now-former Governor Naci Ağbal, who was fired this weekend.
Those moves were on a par with declines seen in the Pound-Dollar and Pound-Euro exchange rates after the Brexit referendum’s outcome became known.
Ağbal, a former finance minister appointed in November to rehabilitate Turkish monetary policy and pull the Lira from a mire of perpetual devaluation and crisis, departed the bank just days after the CBRT surprised markets with a larger-than-expected interest rate rise from 17% to 19%.
“The abrupt replacement of Turkey’s central bank governor tripped up the lira badly overnight, which weighed on other EM currencies though the impact has largely dissipated outside the lira,” says Alvin Tan at RBC Capital Markets.
Last Thursday’s rate rise meant Turkish borrowing costs had almost doubled from their May 2020 low of 8.25%, but still left it short of the 24% high that prevailed in July 2019 before the CBRT threw the concept of inflation-targeting to the wind in favor of steep but inflationary rate cuts. Cuts to the cash rate not only further stimulated the economy, lifting inflation in the process but also helped to drive ‘real’ or inflation-adjusted bond yields to deeply negative levels.
This was a big part of what drove the Lira to repeated record lows in recent years, and although it pared losses on Monday, a return to those lows cannot be ruled out. This is especially if the 8.75% worth of interest rate rises announced between October and March begin to be reversed.
“New Governor Kavcioglu reportedly shares Erdogan’s unorthodox view that high rates are the cause of inflation. We already see TRY trading at 8.16 in Asian markets vs. a close of 7.22 on Friday – and it had been as low as 8.47. Piotr Matys points out that with no FX reserves if we see a Turkish policy easing cycle, it would be prudent to assume any matching set of measures to stabilize the currency are unlikely to be market friendly,” says Michael Every, a global strategist at Rabobank.
Central banks typically use interest rates and other monetary policy tools to control inflation with higher rates deployed to curb rising price pressures. In contrast, lower borrowing costs are used to cultivate inflation wherever it’s found, undershooting a predefined target. President Recep Tayyip Erdogan has never thought much of inflation-targeting, however, and has frequently argued that many other central banks in the world are effectively all doing it wrong.
President Erdogan’s idea is that higher interest rates cause higher inflation and vice versa, which is exactly the purported view of Ağbal’s replacement in the form of Sahap Kavcioglu, a former lawmaker of the governing party who’s said to have frequently criticized increases in Turkish interest rates. Those changes, including last week’s rate rise, were intended to bring inflation down to the 5% target.