FX Watch – Turkish lira weakness not over yet

door: Georgette Boele , Peter de Bruin

FX-Watch - 23 April 2015 - Turkish-lira-weakness-not-over-yet.pdf (207 KB)
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  • Investor sentiment towards Turkey has deteriorated…
  • …weak economic growth continues to weigh on the lira…
  • …and a higher interest corridor is unlikely in the near-term
  • (Geo) political developments are also a headwind
  • We have adjusted our USD/TRY upwards reflecting more lira weakness in the near-term

Investor sentiment towards Turkey weakens…

This year, the Turkish lira has been the weakest currency within our emerging market currency universe. It weakened by more than 13% versus the US dollar to a new all-time low, only the Ukrainian hryvnia did worse. Why has the Turkish lira been out of favour? In short, weak growth and (geo) political uncertainty. The graph below shows the general deterioration in investor sentiment towards Turkey.

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Economic growth continues to weigh on the lira…

For a start, Turkish economic growth is weak. For example, economic growth has slowed dramatically since the approximately 9% growth seen in 2011 to less than 3% in 2014. Also analysts’ expectations for 2015 and 2016 are for modest economic growth.

It is true that other fundamentals have improved such as the current account deficit, fiscal position and overall debt level. However, despite the substantial improvement in the current account deficit, this remains the Achilles’ heel in terms of investor sentiment. It is likely that the US Federal Reserve will hike interest rates by more than expected this year and next year. This will damage currencies with weaker growth and relatively large current account deficits, such as the lira.
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…and higher interest rate corridor unlikely in the near-term…

Yesterday, the central bank left monetary policy unchanged, in line with our expectations. However, financial markets were disappointed, because the central bank did not live up to market expectations. Market speculation had increased that the central bank will tighten monetary policy to support the currency. The decision not the raise interest rates can be explained in one of the following ways. First, the central bank did not hike because of political pressure. Second, the central bank judges that it has already tightened monetary policy; it has pushed the one-week interbank rate to the upper bound of its interest rate corridor. This is now relatively close to the highs seen in January 2014 when it hiked its corridor. Despite leaving rates on hold today, monetary policy has thus become tighter over the coming months. Taking these possible reasons into account, it is unlikely that the central bank will hike in the coming months. The central bank will probably take more of a wait-and-see stance. The rate hike by the Fed may trigger an increase in rates in Turkey as well to avoid a lira currency crisis.

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…while (geo) political uncertainty is a headwind

General elections will be held on 7 June 2015 to elect the 550 members of the Grand National Assembly. A party needs 276 seats for a majority. The opinion polls show a wide variation of results. The governing Justice and Development Party (AKP) will seek a fourth consecutive term in government. The main question is if the AKP manages to win another single party government mandate. This uncertainty and recent commentary (including negative comments about the functioning of the central bank) from Recep Tayyip Erdogan (President) have weigh on investor sentiment towards Turkey. In addition, developments in the neighbourhood (Syria, Iraq) are not supportive for this sentiment. In short, (geo) political developments remain a headwind for the lira.

New USD/TRY forecasts

USD/TRY has recorded new all-time highs, reflecting a sharp deterioration in investor sentiment towards Turkey. Despite the sharp lira weakness, it is likely that the currency will weaken even further in the months ahead. We have adjusted our USD/TRY upwards (weaker lira) to reflect the discussion above. Our new forecasts for USD/TRY are 2.80 for the end of June and then 2.85 for the Q3 2015 until Q4 2016.