Turkey seen raising rates to stabilise the lira – Rabobank

“The recovery of the severely battered lira, which lost more than 40% of its value this year, is driven by market expectations that the central bank may raise interest rates in response to rising inflationary pressures and the risk of financial instability,” notes Ä°otr Matys,  Rabobank EM FX Strategist.

Key quotes

“The size of a potential rate hike on Thursday will be crucial. It would have been rational to expect at least a 1000bps move given the sheer scale of lira’s depreciation and the damage it has already caused to households, corporates and the Turkish economy. That said, a few hundred bps hike is  probably a more realistic scenario if we take into consideration perceived objection to higher interest rates amongst prominent Turkish officials.”

“We therefore anticipate the central bank to raise its 1-week repo rate by 500bps to 22.75% on September 13. Our call is on the hawkish side of expectations based on the market median for a 325bps move, although the range of expectations is very wide from unchanged rates to a 725bps hike, according to a survey conducted by Bloomberg.”

“A 500bps or even higher move accompanied by a very hawkish statement would be a major step on the long path of restoring confidence in the lira and local assets. Should such a hawkish scenario unfold, a corrective pullback in USD/TRY could extend towards the 6.00 level.”

“To reiterate a point we have made before, the central bank’s efforts to stabilise the lira must be accompanied by constructive macro prudential policies from the administration. Treasury and Finance Minister Albayrak continues to make frequent reassuring comments regarding fiscal policy and structural reforms. The market is, however, reluctant to adopt a more constructive view on Turkey until such pledges are followed by concrete measures. Diplomatic tension between the US and Turkey would also have to ease before a sustainable recovery in the lira can be expected. Essentially, a rate hike on its own is unlikely to prove sufficient if the other two crucial elements are not yet in place.”