Turkish lira drops to new low as central bank rate hike seen off limits

(Story was updated with analyst's comment in the ninth paragraph.)

Turkey’s lira fell to a fresh record low against the dollar on Wednesday as speculation persisted that the central bank would keep interest rates on hold at a meeting on Thursday.

The lira traded as weak as 7.6851 per dollar in Istanbul. It was 0.2 percent lower at 7.6746 against the U.S. currency in early afternoon local time. The lira has lost 22 percent of its value this year.

The central bank’s Monetary Policy Committee is expected to keep its benchmark interest rate steady at 8.25 percent at tomorrow’s meeting despite persistent selling pressure on the lira, according to most economists polled by Reuters and the state-run Anadolu news agency this week.

Instead, the bank may raise the interest rate for its late liquidity window (LLW) from 11.25 percent to increase the average cost of funding for banks, which now stands at more than 10 percent. Annual inflation in the country is running at 11.8 percent, meaning real interest rates are negative despite the bank’s tightening monetary policy bias in recent weeks.

"The lira is rapidly approaching 7.70, and likely near 8+ for year-end," said Tim Ash, senior emerging markets strategist at BlueBay Asset Management in London. "If the central bank hopes to have any chance of stabilising the lira it really has to hike rates this week. At the minimum a hike in the LLW."

Rather than raise the benchmark interest rate, the central bank has kept it on hold since June due to opposition from President Recep Tayyip Erdoğan, whose government has ordered state-run banks to flood the economy with cheap loans to boost industrial activity and consumer demand.

The central bank has instead defended the lira by spending tens of billions of dollars of its foreign exchange reserves this year as it seemingly lacked the authority to raise the benchmark rate. Erdoğan opposes higher borrowing costs saying they are inflationary, a view that jars with conventional economic theory, which says interest rates are an effective tool to rein in inflation.

Inflation in Turkey had stood at 8.6 percent in October, before the central bank carried out the lion’s share of rate cuts that have reduced the benchmark from 24 percent last July.

“Clearly the market wants to see the bank making efforts to turn the negative real interest rates back into positive rates with the help of key rate hikes,” said Antje Praefcke, a senior foreign exchange analyst at Commerzbank, adding there was a risk of a sudden selloff in the lira, according to Reuters.

But Erdoğan appears intent on persisting with his low rates, pro economic-growth policies. The government will target an expansion of 6 percent next year after growth of about 1 percent in 2020 despite the impact of the COVID-19 pandemic, Dünya newspaper reported on Wednesday citing a new three-year plan to be announced this week.

Turkey suffered a currency crisis in 2018 partly due to Erdoğan's growth-focused goals, which had threatened to overheat the economy. The country then entered a painful recession, from which it had just recovered when the coronavirus struck in March.