Lira Falls to Record as Local FX Demand Adds to Inflation Woes

The Turkish currency sank to a record low, weighed down by concern that monetary policy remains too loose to curb accelerating inflation.

The lira slid as much as 1.1% to 8.5981 per dollar, poised for a third daily decline this week. The losses were compounded as local accounts bought dollars ahead of large foreign-currency debt repayments, according to two traders who asked not to be named as they are not authorized to speak publicly.

Lira Falls to Record as Local FX Demand Adds to Inflation Woes

The nation’s central bank kept its benchmark interest rate unchanged at 19% for a second meeting this month, saying the pace of price gains had peaked. Yet the currency has weakened more than 13% over the past three months, by far the most among emerging markets, a depreciation that threatens to feed through into higher prices.

“The lira has been on a steady grind lower,” said Henrik Gullberg, macro strategist at Coex Partners. That “is a reflection of monetary policy not looking tight enough to contain inflation expectations,” he said.

Turkey’s consumer inflation quickened for a seventh month to 17.14% in April, driven by higher energy costs. That means Turkey’s real policy rate now stands at less than 2%, exposing the lira to any shifts in investor sentiment. Turkish companies have to roll over $6.9 billion of foreign-currency loans in June, the biggest refinancing hump through March 2022, according to central bank data.

Weakness in the lira also comes amid geopolitical tensions. Turkey pushed its NATO allies into softening the official reaction to the forced landing of the plane by Belarus, Reuters reported on Thursday, citing two unidentified diplomats familiar with the matter. NATO released a two-paragraph statement on Wednesday condemning Belarus’s action.

Central Bank

The lira has been weighed down since the ouster of the central bank’s former hawkish governor Naci Agbal and installing an interest rate ally late March, sending Turkish markets into a nosedive. Since then President Recep Tayyip Erdogan, who holds unorthodox views on the relationship between inflation and interest rates, also replaced three other members of the bank’s rate-setting committee.

Each burst of depreciation risks triggering a fresh lira crisis as it begins to feed back into higher inflation, which the central bank cannot fight off because it is unable to “credibly” hike rates – the familiar “lira spiral,” wrote Tatha Ghose, a senior economist at Commerzbank.

“Because of its inability to hike rates properly, CBRT relies on inflation to cool off via external or other factors so that it can enjoy even a short period of stability,” Ghose said in a report.

The lira was 0.9% weaker at 8.5821 per U.S. dollar as of 2:37 p.m. in Istanbul, while the benchmark Borsa Istanbul 100 Index was little changed after declining as much as 1%. The yield on 10-year government bonds climbed 29 basis points to 18.66%.

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