Toxic Mix Brewing for Ailing Lira as Turkey Economy Shrinks

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  • Turkey’s economy contracts for first time in seven years
  • Lira extends sharpest drop among emerging peers this quarter

Lira Leads Declines Among Emerging-Market Currencies

Defending the lira has just gotten harder.

The central bank is already under pressure from politicians including President Recep Tayyip Erdogan to cut rates and support the economy, which contracted in the third quarter for the first time in seven years. So while “the plunging lira argues for a hike,” the central bank will struggle to raise rates after this data, said Win Thin, the head of emerging markets at Brown Brothers Harriman & Co. in New York.

Thin sees the lira weakening more than 3 percent to 3.6 per dollar, regardless.

Read More: Turkey Economy Shrinks Unexpectedly in Coup Attempt Fallout

The contraction adds to an already poor start to the week for Turkish assets. The twin bombings on Saturday that killed more than 40 people in Istanbul heightened the nation’s political risk just as investors priced in a U.S. interest-rate increase. Meanwhile, a rally in crude oil is threatening to weigh on the country’s import bill and a push to change the country’s constitution to give Erdogan more powers is clouding the political outlook.

The lira has declined 14 percent so far this quarter, even after the central bank raised borrowing costs for the first time in almost three years in November. It traded 0.3 percent weaker against the dollar to 3.4785 as of 4:39 p.m. in Istanbul.

Foreign investors have dumped local currency bonds every week since October, taking their share in the market to below 20 percent, the lowest since 2012. The government on Tuesday sold 10-year bond at a record-high yield of 11.55 percent.

Kaan Nazli, who helps oversee almost $10 billion of emerging-market debt at Neuberger Berman Europe Ltd. in The Hague, is more cautious about Turkey’s local bonds after data showed the economy contracted. Because policy makers will struggle to defend the lira, the currency’s risk is now “greater than peers like Brazil and Indonesia,” he said.

The central bank’s next scheduled interest rate decision is on Dec. 20.