Turkey’s lira may extend a rally against the dollar this year, strengthening to 6.25 per dollar by December, as investors become more confident that the central bank’s tight monetary policy stance will stick, Capital Economics said.
President Recep Tayyip Erdoğan, who has sacked two central bank governors in two years, may allow policymakers to keep interest rates elevated, which will help to slow inflation and draw in foreign capital, Capital Economics said in a report late on Wednesday.
“It appears that president Erdoğan has caved to pressure from within his own party over economic management,” said Jason Tuvey, senior emerging markets economist at the London-based economic research and consultancy company. “Investors’ views towards Turkey have improved more quickly than we had previously envisaged.”
Turkey’s central bank has hiked its benchmark interest rate to 17 percent from 10.25 percent since early November when the lira hit a record low of 8.58 per dollar and Erdoğan hired former finance minister Naci Ağbal to head the central bank. The lira has since rallied through 7 per dollar as foreign capital returned to the bond market.
Over the past few years, Erdoğan has sought to interfere in monetary policymaking, saying high interest rates are inflationary, a view that contradicts with conventional economic wisdom.
Capital Economics’ forecast for the lira is the most optimistic yet among foreign financial institutions. Last week, HSBC and French bank Societe Generale predicted that the currency would rally to 6.5 per dollar by the year-end. Eariler this week, Citigroup cashed in a lira-euro trade predicting renewed weakness for emerging market currencies.
The lira traded little changed at 6.97 per dollar on Thursday morning local time.
The outlook for the lira is also improving after the risk premium for Turkish assets declined, reflected in a 200-basis point narrowing in Turkey’s dollar bond spreads since early November, far more than in most other major emerging markets, Tuvey said.
Political risk has also eased amid signs that Erdoğan’s government is seeking to mend ties with the United States and the European Union, Tuvey said. Those initiatives may go some way to reducing the threat of harsh economic sanctions, he said. Turkey has been immersed in a diplomatic spat with the United States over its acquisition of Russian S-400 missiles and embroiled in disputes over territory with EU members Greece and Cyprus
Tuvey said he expects the central bank to keep monetary conditions tighter than most people expect. Capital Economics forecasts that Ağbal will leave the benchmark rate unchanged throughout the year, while the market consensus is for a 3.75 percentage point cut, he said.
Still, investors and analysts are not fully convinced that the central bank will tackle Turkey’s inflation problem, according to Tuvey. Annual consumer price inflation edged up to 15 percent in January and long-term inflation expectations remain elevated and well above the bank’s medium-term target of 5 percent, he said.
“This is likely to reflect the fact that we are still in the early stages of the CBRT’s policy shift and it will take time for the central bank to bring down and anchor inflation expectations,” Tuvey said. “Overall, though, investors’ views towards Turkey have improved more quickly than we had previously envisaged.”