Turkish lira erases 2021 gains on global sell-off, monetary policy concerns

Turkey’s lira weakened for a fourth-straight day against the dollar early on Friday, driven lower by a rise in U.S. bond yields and concerns about monetary policy.

The lira dropped by as much as 1.9 percent to 7.47 per dollar, erasing all the gains it made this year, before recovering to trade little changed at 7.33 against the U.S. currency. It had traded as strong as 6.88 per dollar last week.

Yields on 10-year U.S. Treasuries have risen the most since 2016 this month, prompting investors to sell high-yielding but riskier emerging market assets. Concerns among investors that Turkey’s central bank will avoid further hikes to interest rates due to political pressure have added to the lira selloff.     

The lira had rallied by 20 percent from a record low of 8.58 per dollar since early November after President Recep Tayyip Erdoğan pledged market-friendly economic policies and replaced the central bank governor and treasury and finance minister.

New central bank governor Naci Ağbal raised interest rates to 17 percent from 10.25 percent in November and December but has kept rates on hold since despite mounting inflationary pressures. Meanwhile, the government has yet to announce a package of economic reforms.

"Ağbal has been excellent since he was appointed - like a breath of fresh air. But I really think the last two policy decisions were mistakes," said Tim Ash, senior emerging markets strategist at BlueBay Asset Management in London. "Signalling inflation is going high but then not acting was a mistake. It left the lira vulnerable again."

Over the past week, Erdoğan and his new finance minister have defended former Treasury and Finance Minister Berat Albayrak’s unorthodox economic policies, which led to last year’s lira sell-off. Albayrak is the president's son-in-law. Erdoğan's support for Albayrak has raised concerns that he may return to government.

On Wednesday, Ağbal hiked lira reserve requirements for banks and lowered them for dollars and gold to defend the lira. Some investors interpreted the decision as reluctance on the central bank’s part to raise interest rates further and as a throwback to the unconventional policies that it employed last year.

Goldman Sachs analysts wrote in a report this week that market participants may see the central bank’s decision on the required reserves as a sign that it is unable to deliver tighter monetary policy via a regular rate hike. Erdoğan opposes higher interest rates saying they are inflationary and has replaced two central bank governors in two years.  

Consumer price inflation in Turkey accelerated to 15 percent in January and is expected to head higher in the coming three months. The central bank’s year-end goal for inflation is 9.4 percent.