News & Analysis

The Turkish lira has been depreciating on a trend basis ever since the onset of the pandemic, driven domestically by a combination of political interference, elevated inflation, and economic unorthodoxy at a time when external market conditions turned less supportive for EM assets.

While the return of more orthodox economic policy since President Erdogan won re-election in May 2023 supported a slower pace of depreciation, this has only just begun to materialise as previous rate hikes were merely catching up with inflation, while current account pressures remained and confidence in the CBRT was hampered by another scandal. This saw the Turkish lira continue to underperform its forward implied rate.

However, with inflation pressures now set to moderate on a sequential basis, the CBRT confirming its commitment to combat high inflation through orthodox measures with a shock rate hike in March, and the lapse of election uncertainty following the completion of local elections in early April, the Turkish lira is now starting to stabilise.

In fact, TRY was the best performing EM currency over the past month, trading flat against the dollar amidst a broader backdrop of EM FX weakness and higher US rates. We think the past month marks something of an inflection point for the lira, with the currency likely to transition from underperforming its forward implied rate to outperforming it, conditional on inflation pressures continuing to moderate, supported by unimpaired orthodox fiscal and monetary policy.

Having underperformed its 1-year forward rate in recent years, medium-term forwards now exhibit a risk-premium, which we think is overly bearish on the lira’s prospects 

Over the medium-term, the combination of lower headline inflation, the CBRT’s likely preference to keep rates higher for longer, and improved current account balances should support a slower pace of TRY depreciation.

On inflation, while the headline rate is likely to spike in the coming months owing to the lagged passthrough of currency depreciation on goods inflation and positive base effects, the stabilisation in the lira and moderation in domestic driven inflation pressures support disinflation until year-end.

With the CBRT likely to maintain a higher for longer stance, the lira’s improving real rate profile should reduce local dollarisation pressures.

Coupled with continued improvement in Turkey’s current account, which should soon flip into surplus as the narrowing trade balance deficit is boosted further by seasonal tourism inflows, this should enable the CBRT to continue accumulating foreign exchange reserves without putting pressure on the lira.

While Turkey’s tighter macro policy stance likely means inflation has now peaked, the disinflation path is likely to remain slow until year-end

That said, we don’t expect the lira to rally outright, but instead to outperform its outright forward rate.

Ultimately, while inflation pressures are moderating in Turkey, they remain elevated and highly volatile, which should limit the extent to which residents de-dollarise. Moreover, despite the CBRT’s recent hawkish tilt, we suspect they will respond to any marginal inflation overshoot by relaying a higher for longer message to markets as opposed to hiking rates further. This should limit the extent to which investors turn bullish on Turkish assets, especially as the external environment has turned considerably less conducive for risk due to the continual flare-ups in geopolitical tensions and structurally higher US rates.

Monex’s May forecasts

 

 

Author:
Simon Harvey, Head of FX Analysis

 

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