Strong interest rate hike in Turkey causes pound to rebound

Posted on Nov 19, 2020 at 12:36 PM

Naci Agbal, the new governor of the central bank, has decided to strike hard to counter inflation and restore confidence in the currency. The one-week repo rate was raised by 475 basis points to 15%, the highest level in emerging countries. Markets were anticipating monetary tightening 400 basis points less. The central bank warns that further monetary tightening is expected as long as inflation persists.

The Turkish currency rose after this announcement. The dollar fell 2% from 7.71 to 7.56 pounds, and the euro fell 1.4% from 9.11 to 9 pounds.

“It was better if the new governor hit hard to deliver the final blow to those who bet on the fall of the pound. If this time he obtained President Edogan’s authorization to raise interest rates, he is not sure that this will be the case in the future ” says Timothy Ash, strategist at Bluebay in a view published by the agency PA Turkey.

Erdogan and 1-digit inflation

The day before the central bank meeting, President Erdogan had indeed declared that “We shouldn’t let our investors get crushed by high interest rates”. He added that “Our goal is to achieve single-digit inflation as soon as possible”. The price increase is currently around 12%.

Less volatile growth

“Industrial production grew 7.5% in the third quarter and year on year. Growth should be stable this year, a much better performance than most emerging countries. The tightening of monetary policy will weigh on activity in 2021 but its benefit will be a more stable currency and more sustainable and less volatile growth ” says Robin Brooks, chief economist at the Institute of International Finance. Before the dismissal of the governor of Turkey’s central bank and the resignation of the finance minister, the consensus of economists predicted GDP growth of 4.5% next year.

Goldman Sachs pessimistic about the pound

The return of foreign capital to Turkish markets will promote the currency’s rebound. In the next 12 months, Goldman Sachs bank anticipates a 15% rise in Turkish stocks, an increase that is twice as low as those expected for their Brazilian, Mexican and Colombian counterparts. The American bank remains pessimistic about the evolution of the Turkish currency in a scenario of uncontrolled inflation (13.4% in 2021). It predicts a 20-25% drop in the Turkish currency within 3-12 months. The dollar would settle between 9.25 and 9.50 Turkish lira.

“Frontier” currency

“After the 2008 financial crisis, the Turkish lira behaved like other risky emerging currencies. This was no longer the case this year, its behavior was that of a currency of “frontier” markets (Editor’s note: the less developed markets which have not yet reached the status of emerging markets), with periods of very low volatility punctuated by sudden movements ”, notes Goldman Sachs. This downgrade of the Turkish currency is linked to the weakening of the central bank, under the influence of political power, and repeated massive interventions on the foreign exchange market. Despite its rebound, the real exchange rate of the Turkish lira is still less than half of its level 10 years ago. It is the worst performance behind the Brazilian real and South African rand.

Hedge funds against banks

Hedge funds and management companies contributed the most to the 10% rebound in the Turkish lira the week after Naci Agbal’s appointment, according to Citi bank. Hedge funds have also bought heavily Hungarian forints and Polish zlotys. The banks took advantage of the rebound of the Turkish lira to give up. This was also the case for companies, but to a lesser extent.

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