Lira’s Fall to Record Likely Heralds Worse to Come for Inflation

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The lira’s latest downswing is taking a toll on Turkey’s inflation outlook.

The emerging world’s worst performer against the dollar last month, Turkey’s currency has fallen victim to a campaign of stimulus that’s consisted of steep interest-rate cuts alongside a surge in fiscal spending and a government-sponsored credit push. The lira declined to an all-time low on Thursday.

Lira’s Fall to Record Likely Heralds Worse to Come for Inflation

Although the policies helped contain the economic damage from the coronavirus pandemic, Turkey will now have to contend with faster price growth and pressure to tighten monetary policy. Inflation picked up less than forecast in August but remained close to an annual 12%. The central bank projects it will end the year at 8.9%.

“Given the weakness in the lira, the pass-through likely underpinned inflation,” said Timothy Ash, a strategist at BlueBay Asset Management in London. “High and sticky inflation is one of the factors helping drive dollarization.”

The lira reached historic lows and depreciated over 5% in August. The currency touched an unprecedented 7.4243 per dollar and was trading 0.5% weaker as of 11.47 a.m. in Istanbul. It’s down almost 20% for the year.

Lira’s Fall to Record Likely Heralds Worse to Come for Inflation

The currency’s slide is likely to be “the key driver of inflation in August and September,” Goldman Sachs Group Inc. economists including Murat Unur said in a report to clients before the data release. They expect inflation to remain around 12% in the coming months before falling to 11.7% by the end of the year.

Although policy makers led by Governor Murat Uysal have kept the benchmark at 8.25% during the past three meetings, they have already started tightening liquidity by using fringe tools and ceasing to provide funding at their cheapest rate, the one-week repo.

What Our Economists Say...

“Currency depreciation remains a lingering threat and could keep Turkey’s price growth in double digits throughout the year. The lira’s weakening so far this year poses upward risks to the central bank’s inflation outlook.”


-- Ziad Daoud

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Tightening policy by the backdoor may be a way to avoid angering President Recep Tayyip Erdogan, but it’s unlikely to help contain inflationary pressures. The average cost of cash provided by the central bank rose to 10.16% on Wednesday, compared with as low as 7.34% in July.

“In order to hike the one-week repo rate, it will have to overcome Erdogan’s reluctance to let this happen,” said Sebastien Barbe, the Paris-based head of emerging-market research and strategy at Credit Agricole SA. “This could occur when the depreciation pressure on the lira intensifies further, possibly in the course of the fourth quarter.”

©2020 Bloomberg L.P.

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