Turkish lira to drop to 8 per dollar, more abrupt falls possible – Capital Economics

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Turkey’s lira is set to extend a record low and decline to 8 per dollar this year because the authorities are failing to placate concerned investors, Capital Economics said.

The Turkish central bank’s dovish monetary policy stance – it has failed to raise its benchmark interest rate despite losses for the lira of more than 22 percent this year – is at the core of the lira’s problems, London-based Capital Economics said in a report published on Wednesday.

The fair value of the lira has also shifted downwards due to the outbreak of the COVID-19 pandemic, pressuring the currency further, said Jason Tuvey, senior emerging markets economist at Capital Economics.

More a abrupt falls in the lira were possible in the near term, which could force the central bank to act and hike interest rates aggressively, he said.

“The coronavirus crisis has dealt a significant and long-lasting blow to Turkey’s tourism sector and thus its services exports and current account position. A weaker lira forms part of the adjustment,” Tuvey said.

The lira fell to as low as 7.72 per dollar on Thursday, its weakest level on record. It traded little changed at 7.70 per dollar in late morning in Istanbul.

Tuvey said the decline in the lira was expected to continue in 2021. The currency could fall to 9.25 per dollar by the year-end, he said.

Turkey’s central bank is due to convene for its monthly meeting on interest rates on Thursday, with most economists ruling out a hike in the benchmark rate of 8.25 percent. Under political pressure, the bank has preferred to tweak other monetary policy tools to raise borrowing costs for bank as the lira fell in recent weeks. Banks’ average cost of funding now stands at around 10.6 percent compared with about 7.4 percent in July.

Still, borrowing costs in Turkey remain negative when taking account of inflation. Annual consumer price inflation in the country stood at 11.8 percent in August.

It is increasingly likely that the central bank will shift all funding for commercial banks to the so-called late liquidity window, which lies at the top of a so-called interest rate corridor at 11.25 percent, Tuvey said.

The central bank has kept the benchmark interest rate unchanged since June. It had slashed borrowing costs from 24 percent last July when President Recep Tayyip Erdoğan sacked and replaced its governor for failing to lower interest rates.

Tuvey said the central bank had hiked rates substantially following a currency crisis in the summer of 2018, but this time its hands appear tied.

“The central bank seems loath to hike official policy rates due to pressure from President Erdoğan,” he said. “Policymakers’ shift in focus towards maintaining a “competitive” lira suggests that they are now more willing to let the lira weaken.”

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