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Turkey’s monetary tightening supports lira

Turkish policymakers surprised investors by tightening monetary conditions on Wednesday, helping to support the lira on a day of widespread weakness across emerging market currencies and prompting some to rethink their pessimism towards the country.

While the Turkish central bank kept its main interest rates unchanged, it defied expectations by raising the late liquidity lending rate by 50 basis points.

Describing the move as “a hawkish surprise”, Win Thin, a foreign-exchange strategist at Brown Brothers Harriman, said it gave the bank “a little more room to tighten monetary conditions as needed”.

The lira, which has risen nearly 5 per cent in the past seven days, climbed to TL3.57 against the dollar, its highest level since late February.

“Tight liquidity remains a major source of support for the Turkish currency, which is still relatively undervalued,” said Piotr Matys, at Rabobank. “The 3.50 level is a valid short-term target for the lira against the US dollar.”

In contrast, most EM currencies were nursing losses against a well-supported dollar on Wednesday, including the Brazilian real, the Russian rouble and the South African rand. All dropped more than 1 per cent.

Investors have shunned the lira this year, put off by Turkey’s economic slowdown, rising inflation and president Recep Tayyip Erdogan’s expansion of his powers. In January, the lira was the worst performing EM currency, falling to just below TL4.00.

But the lira has begun to look more stable, even before the president secured victory in last week’s constitutional referendum which enhances his powers.

Inan Demir, a research analyst at Nomura, said that even before the CBT meeting, the lira was “already benefiting from the improved sentiment after the referendum and supportive global backdrop”.

Mr Matys said the lira was getting support from the idea that political uncertainty following the constitutional referendum should gradually diminish “and that perhaps the governing AKP party will focus on economic reforms”.

Investors should start to be bullish on the lira, according to ING. The lira looks an attractive funding currency, and it looks cheap, while the central bank’s inflation target-setting is regaining credibility because it is keeping interest rates high.

“And of course, the external environment remains supportive for the time being,” said ING strategist Petr Krpata, targeting a break above the year’s high of TL3.5560.

But Mr Demir of Nomura warned that any upside for the lira would be shortlived. Inflation could rise to around 12 per cent, he said, while tightening of the late liquidity window would be insufficient to support the lira in risk aversion periods.

A cabinet reshuffle, presidential and parliamentary elections and geopolitical tensions should keep the Turkey risk premium high. “Consequently, we expect currency depreciation pressures to re-emerge later in the year,” said Mr Demir.