Lira's Moment of Truth Arrives With Silence on Reserves Near End

(Bloomberg) -- The lira’s latest moment of truth increasingly hinges on the Turkish central bank’s words rather than action.

By unexpectedly dropping its explicit pledge last week to tighten monetary policy if needed, the central bank left the currency exposed to another selloff. Already the emerging world’s worst performer in April, the lira could depreciate 15 percent in the next 12 months, according to Goldman Sachs Group Inc.

The stakes are now higher for a quarterly inflation briefing on Tuesday, when Governor Murat Cetinkaya is expected to shed light on what economists say is as much as $20 billion of net reserves that can’t be accounted for.

Survey of ExpectationsCentral Bank ProjectionOfficial Target
Year-end 201916.23%14.6%5%

For over a month, Turkey watchers have been struggling to square official reserves data with regular inflows and outflows that together make up the changes in the central bank’s accounts. The conundrum left analysts questioning whether policy makers were using short-term borrowings to inflate their holdings and, if so, why the stash wasn’t increasing as fast as it should have.

“FX markets have demonstrated they will penalize the central bank if it’s not convincing,” said Julian Rimmer, a trader at Investec Bank Plc in London. The governor “has to strike a hawkish tone and convince investors they really are committed to taming inflation and their Treasury operations are rational.”

Lira's Moment of Truth Arrives With Silence on Reserves Near End

Currency losses are creating a dangerous feedback loop by fanning inflation and piling pressure on authorities to lean against the market even as reserves run out. A sudden drop in the stockpile in March gave way to the lira’s biggest single-day drop since last year’s currency crash and has since been followed by four straight weeks of declines.

“If foreign investors buy back their dollars and leave, while locals are also buying dollars, there would be major pressure on the lira,” said Akin Tuzun, an analyst at VTB Capital. “The central bank, with its limited net reserves, might have a challenge to control this pressure. Therefore, it is critical for the authorities to re-build foreign investor confidence.”

The challenging outlook only underscores why the central bank’s decision to soften the language in its statement caught many off guard. The earlier guidance had helped anchor the lira even as inflation held at nearly four times the official target of 5 percent and the economy plunged into its first recession in a decade.

Instead, its stance now “will be determined to keep inflation in line with the targeted path.” The shift is deepening concerns that President Recep Tayyip Erdogan and his party, stung by major setbacks in March local elections, are prevailing in their push for an expansionary policy that conditions don’t warrant.

Meanwhile, despite the government’s efforts to keep food costs in check, annual inflation actually inched up slightly in March to just under 20 percent. The central bank’s survey in April found that expectations for price growth at the end of this year rose from the previous month.

Lira's Moment of Truth Arrives With Silence on Reserves Near End

“While the policy rate is high enough to achieve a balanced current account, a renewed series of cuts will not help with anchoring inflation expectations or stemming the degree of ongoing dollarization in the economy,” Goldman strategists led by Zach Pandl said in a note. Without the tightening bias, “the central bank opened the door to not only a rate cut at its next meeting on June 12 but also further currency depreciation.”

©2019 Bloomberg L.P.