Bigger-than-expected interest rate hike boosts the credibility of Turkey’s new central bank chief, say analysts.
Turkey’s lira plunged 15 percent to near its all-time low on Monday following President Tayyip Erdogan’s shock weekend decision to sack a hawkish central bank governor and install a like-minded critic of high interest rates.
The appointment of Sahap Kavcioglu, a former banker and ruling party lawmaker, in the early hours on Saturday, marked the third time since mid-2019 that Erdogan has abruptly fired a central bank chief.
Kavcioglu had sought to ease concerns about a sharp selloff in Turkish assets and a pivot from rate hikes to cuts in a 90-minute call on Sunday, in which he told bank CEOs he planned no immediate policy change, a source told the Reuters news agency.
The currency tumbled to as weak as 8.4850 to the dollar, from 7.2185 on Friday, back to levels touched in early November when it reached an intraday record of 8.58.
It recovered about half of those losses after Finance Minister Lutfi Elvan said Turkey would stick to free market rules, reaching 7.76 at 0620 GMT, 7% weaker from Friday.
“The lira is being smashed by investors fearing that the custodian of its value does not share their hopes for a stable currency underpinned by positive real interest rates,” said Westpac senior currency strategist Sean Callow, adding that the lira may not yet have found a bottom.
Turkey “will be left with two choices, either it pledges to use interest rates to stabilise markets, or it imposes capital controls,” said Per Hammarlund, senior EM strategist at SEB Research.
Finance Minister Elvan said authorities were determined to stick to free-market rules and a free-floating currency regime. He said in a statement the macro policy framework would continue until there is a lasting fall in inflation.
Goldman Sachs and other investment houses had expected a sharp dive in the lira and Turkish assets given the new governor’s dovish and even unorthodox views, and what was seen as the latest damage to the bank’s credibility amid years of policy interference that has dogged the major emerging market economy.
The weekend overhaul could soon reverse the hawkish steps taken by predecessor Naci Agbal, analysts said, and nudge Turkey towards a balance of payments crisis given its depleted buffer of foreign currency reserves.
One possible scenario would see the lira swing as much as 15 percent in both directions in Monday’s European session as “[The Turkish lira] sets off on a roller-coaster ride driven by capital flight, central bank interventions and bargain hunters,” SEB Research wrote in a client note.
Erdogan fired Agbal two days after a sharp rate hike that was meant to head off inflation of nearly 16 percent and a dipping lira.
In less than five months on the job, Agbal had raised rates by 875 basis points to 19 percent and regained some policy credibility as the lira rallied from its nadir. But the currency gave back most of those gains in less than 10 minutes as the week’s trade began.
“It is going to be a dark and long day on Monday,” said one Turkish fund manager.
Cristian Maggio, a strategist at TD Securities, predicted a 10- to 15-percent lira depreciation over the coming days.
The overhaul “demonstrates the erratic nature of policy decisions in Turkey, especially with regard to monetary matters (and risks) looser, unorthodox, and eventually mostly pro-growth policies from now on,” he said.
On the call with Turkish bankers, Kavcioglu said any policy change would depend on lowering inflation, which he said was the primary goal, the source familiar with the call said.
Kavcioglu said the current policy approach would continue, the source added. The central bank did not immediately comment.
In a statement on Sunday, Kavcioglu said the bank would focus on permanently lowering inflation, which has been stuck in double digits for most of the last four years.
A former member of parliament for Erdogan’s AK Party (AKP), Kavcioglu has espoused the unorthodox views shared by the president. He wrote that high rates “indirectly cause inflation to rise,” in a newspaper column last month.
Weekend of questions
Agbal’s latest rate hike of 200 basis points on Thursday led to a more than 3 percent lira rally.
His hawkish stance dramatically reduced credit default risks associated with Turkey and started to reverse a years-long trend of investment funds abandoning local assets.
But after Erdogan removed Agbal, investors told Reuters they had worked through the weekend to predict how quickly Kavcioglu might cut rates – and by how much the currency would retreat.
The heads of some local treasury desks had estimated offers up to 8.00 on Monday. At Istanbul’s Grand Bazaar on Saturday, one trader said a dollar bought 7.80-7.90 of the local currency.
Wall Street bank Goldman told clients it was reviewing investment recommendations and predicted a “discontinuous” drop in the lira, and a “front-loaded” rate-cutting cycle.
The overhaul meant capital outflows appeared likely and a rapid adjustment in the current account may be necessary since markets would shy away from funding Turkey’s chronic deficits, it said.
Concerns over central bank independence have exacerbated Turkey’s boom-and-bust economy and record dollarisation, and prompted last year’s unorthodox and costly policy of foreign exchange interventions to support the lira, economists say.
Last year, Turkish banks spent more than $100bn of the nation’s foreign reserves to support the sinking currency, according to Goldman Sachs. That prompted calls by Turkish opposition for a judicial probe into the nation’s official reserves.
The lira has lost half its value since a 2018 currency crisis.
Kavcioglu said in the statement that policy meetings will continue to be held on a monthly schedule, suggesting any rate cuts may wait until the next planned meeting on April 15.