Investors Signal Lira Needs More Than Words to Arrest Decline

Updated on
  • Currency continues plunge even as central bank pledges to act
  • Senior Turkish officials have called for lower borrowing costs

Lira Replaces Rand as World's Most Volatile Currency

The Turkish central bank’s thinly veiled pledge to take action to stem the lira’s decline bought only a short reprieve before the slump continued.

By just after 3 p.m. on Tuesday in Istanbul, the lira was trading down 1.7 percent against the dollar -- weaker than its level prior to the central bank’s statement about an hour earlier and continuing a trend that’s made it the world’s worst-performing major currency in 2017.

The drop was a clear message from investors: nothing short of higher interest rates would ease the pressure, a step that would put policy makers at odds with President Recep Tayyip Erdogan’s calls for lower borrowing costs to support growth in the wake of July’s failed coup. With demand for riskier assets weaker since Donald Trump’s election victory and Turkey hurt by instability and terrorist attacks, the bank has been unable to stem the lira’s decline even with its first rate increase in almost three years in November.

The central bank said it is monitoring “excessive volatility” in markets and pledged to tackle “unhealthy price formations inconsistent with economic fundamentals.” The statement, which included measures to boost foreign-exchange liquidity, didn’t include any hint of a future change in interest rates.

‘Afraid’

“Worst case: the market takes this as a signal that they’re afraid to actually hike rates properly,” said Paul McNamara, a London-based emerging markets fund manager at GAM Ltd., which oversees about $65 billion. The new measures will tighten lira liquidity “a little bit,” but the bank will need to do much more to reverse the currency’s decline, he said by e-mail.

The lira, which trimmed losses to about 0.7 percent immediately after the central bank’s statement, was trading down 1.5 percent at 3.7688 per dollar at 6:42 p.m. in Istanbul.

“We have always maintained that providing FX liquidity to the banking system is not really necessary -- nor is it a sufficient part of a solution to stop lira depreciation,” Commerzbank AG analyst Tatha Ghose said by e-mail. Prior to the statement, Ghose wrote in a note to clients he expects a 50 basis-point rate increase this month, but even that wouldn’t be sufficient to reverse the lira’s downward trend.

The lira has replaced South Africa’s rand as the world’s most volatile currency, as a gauge of expected exchange-rate swings jumped on Tuesday to the highest level in almost three years. Option traders are also favoring lira puts over calls by the most in a month.

On Tuesday, the central bank lowered the level of foreign-exchange reserves it requires commercial lenders to hold by half a percentage point -- a move it said would add $1.5 billion of liquidity. It also limited their borrowing in interbank money markets to 22 billion liras, effective on Wednesday.

Economy Minister Nihat Zeybekci reiterated the government’s preference to avoid raising rates to boost the currency in an interview before the central bank statement. While damage from a weak lira would likely be temporary, higher borrowing costs would permanently damage the economy, he said.

Zeybekci and other senior officials have frequently argued that higher borrowing costs will spur inflation and slow growth.

— With assistance by Constantine Courcoulas, and Firat Kozok

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