Turkey’s central bank faces a key decision on interest rates later on Wednesday as further monetary easing may spark fresh lira weakness.
Economists are divided on whether the central bank will lower its benchmark interest rate and by how much. Polls by Reuters, Bloomberg and the state-run Anadolu news agency point to a reduction of 50 basis points, but some economists see no change and others a larger 75 basis-point cut.
Turkey’s central bank has slashed interest rates to 11.25 percent from 24 percent in July, when President Recep Tayyip Erdoğan sacked and replaced its governor. The lira has now hit its weakest levels since May as investors fretted over the decision and violence in neighbouring Syria intensified.
“With the lira showing noticeable softness in recent weeks, despite heavy state bank FX selling, I think this decision is a key one,” Tim Ash, senior emerging markets strategist at BlueBay Asset Management in London, said in emailed comments. “If they continue to cut it’s hard to see the trend softness in the lira stopping.”
The lira fell 0.3 percent to 6.077 per dollar as of 11:54 a.m. local time in Istanbul, extending lows posted over the past week. State-run banks have supported the currency in recent months by selling dollars.
However, the banks, acting on government orders, now have limited firepower and the central bank’s foreign currency reserves are limited, said Fadi Hakura, who heads the Turkey Project at Chatham House in London.
“So far, they have spent over $37 billion over the last two years in a futile effort to buttress the lira,” Hakura said in a report this week. “This level of involvement in currency markets cannot be maintained.”
The lira slumped by 28 percent against the dollar in 2018, when a currency crisis swept through financial markets leading to a severe economic downturn. It weakened by 11 percent last year. Since the crisis, the government has pump-primed the economy with cheap loans and tax reductions, raising the spectre of further financial instability.
Should the lira weaken further - likely led by selling by Turkish deposit holders - Turkey may be forced to impose capital controls, Hakura said.
“If Turkey’s limited foreign reserves cannot satisfy the domestic dollar demand, the government may have to impose comprehensive capital controls and allow for a double-digit depreciation in the value of the lira to from its current level, with significant repercussions on Turkey’s political stability and economic climate,” Hakura said.
