Turkish lira extends record low as bank seen shunning rate hike calls

Turkey’s lira fell to a new record low against the dollar on Tuesday as economists speculated that the central bank would avoid hiking its benchmark interest rate.

The central bank’s Monetary Policy Committee meets on Thursday to decide on interest rates. The benchmark, which stands at 8.25 percent, will not be increased, according to most economists polled by Reuters, Bloomberg and the state-run Anadolu news agency.

The lira fell 0.4 percent to 7.66 per dollar in Istanbul trading, taking losses this year to 22 percent. The central bank has slashed the benchmark rate from 24 percent in July last year and kept it unchanged since May, preferring to tweak other policy tools to defend the lira and raise banks’ borrowing costs.

Investors in Turkey are calling on the central bank to end its unconventional monetary tinkering, which has included increasing its so-called late liquidity window rate to 11.25 percent. It should rather hike the benchmark rate, which stands at below annual inflation of 11.8 percent, to help bolster the lira and slow price increases, they say.

But Central Bank Governor Murat Uysal is under political pressure from President Recep Tayyip Erdoğan to keep interest rates low to boost the economy. Erdoğan sacked Uysal’s predecessor last year for failing to cut borrowing costs. Last month he said that he hoped rates would fall further.

Erdoğan says interest rates are inflationary, contradicting conventional economic wisdom.

U.S. investment bank JPMorgan said it expected the central bank to increase the late liquidity window rate. The hike should total at least 100 basis points, or 1 percentage point, to be meaningful, it said.

“We expect the central bank to continue avoiding a formal rate hike and to use the interest rate corridor to deal with risks to price and financial stability,” JPMorgan said in a report. “While this will almost certainly not be as effective as a formal hike, it could still provide some breathing room.

“We expect the central bank to remain reactive and to continue with this strategy in the coming months. Only if this strategy proves ineffective and the lira comes under significant depreciation pressure, would we see a formal rate hike, in our view.”

The central bank resisted calls for a big increase in interest rates in the months leading up to a currency crisis in the summer of 2018, only for it to hike borrowing costs substantially when the lira sank to a record low.

Rather than raise interest rates, the central bank has spent tens of billions of dollars of its foreign exchange reserves this year defending the lira.

Meanwhile, the government has flooded the economy with cheap loans from state-run banks, stoking demand for imports. That in turn has widened the current account deficit, raising concerns among investors for the balance of payments and further economic instability. Turkey must finance any shortfall in the current account with foreign currency earnings, which have shrunk due to a slump in inward investment and revenue from tourism.

Ratings agency Moody's Investors Service warned last week of a possible balance-of-payments crisis in the country as it cut Turkey’s debt rating to ‘B2’, five levels below investment grade, the lowest grade it has ever given. That put Turkey on a par with Egypt, Rwanda and Jamaica.

Moody’s also drew attention to the erosion in Turkey’s foreign currency reserves and increasing dollarization of the economy.

Erdoğan responded by saying Turkey's economy was on the rise and not dipping.

"Do what you want to do, your ratings are of no importance," he said on Saturday.