Turkish lira sinks to record low after unconvincing rate hike

ISTANBUL (Reuters) – The Turkish lira weakened as much as 3.3% to a record low on Friday, extending losses a day after the central bank’s big rate hike failed to reassure markets that President Tayyip Erdogan it was abandoning its long-held unorthodox policies.

The lira hit a record low of 25.74 against the dollar at 1006 GMT, down 27.3% this year, and was at 25.6480 at 1039 GMT.

The central bank raised its benchmark rate by 650 basis points to 15% on Thursday, well below expectations for a larger initial tightening that analysts say would have underscored a long-term commitment to fighting inflation.

“The transition appears to be more gradual than we thought,” Goldman Sachs (NYSE:) said in a note.

The central bank said it would go further “in a timely and gradual manner” after its first meeting with new governor Hafize Gaye Erkan, whom Erdogan appointed after his election victory last month.

The new Finance Minister, Mehmet Simsek, highly regarded by financial markets, reinforced the U-turn message by saying that “the path to price stability will be gradual but steady.”

The move marked a turnaround after years of monetary easing in which the one-week repo rate had dropped from 19% to 8.5% in 2021 despite rising inflation.

In a Reuters poll, the median estimate was for a 21% increase. Analysts said the smaller move suggested Erkan may have limited space to aggressively tackle inflation under Erdogan, who has eroded the bank’s independence in recent years.

Reflecting the disappointment in the markets, the lira has fallen 8.5% since Thursday’s rise.

Forward swap markets were trading it at 33 to the dollar a year from now compared to around 30 before the rate hike.

Goldman said the monetary tightening suggests the bank plans to stick to macroprudential measures “at least for now,” adding that “it will be difficult to fully float the (lira) without having an interest rate anchor.”

The central bank is likely to eventually raise rates to a level “consistent with prices in the deposit market,” the Wall Street bank added.

RELAXATION OF INFLATION

After hitting a 24-year high above 85% last year due to Erdogan’s urged rate cuts, inflation dipped to just below 40% in May. Real rates are deeply negative and the central bank’s key rate is also below deposit rates that run as high as 40%.

A senior Turkish official said that a larger increase could have caused problems for the banking sector and that gradual steps prevent sudden volatility. “Advancing according to the balance between inflation and interest rates with an eye on real rates is one of the priorities now,” the person told Reuters.

Turkey’s international bonds stabilized and longer-term issues saw small gains after sharp falls on Thursday in the wake of the rate decision, Tradeweb data showed.

However, the cost of insuring exposure to the country’s debt through credit default swaps rose for the second straight session to stand at 518 bps, having added nearly 50 bps since last Friday’s close, S&P Global data showed. (NYSE:) Market Intelligence.

Erkan will meet a group of bank executives on Friday, a banking source told Reuters, after Simsek met with them last week and discussed problems in the sector.