Following President Recep Tayyip Erdogan’s triumph in the 2023 presidential election, the Turkish lira declined, reaching record lows. Notably, Erdogan holds the unorthodox belief that boosting interest rates will push inflation higher. For this reason, many economists and market analysts anticipate his unorthodox policies to continue and weigh on the lira.
Turkey has faced years of financial problems that have led to a large budget hole, high inflation and a tiny pile of FX reserves, all factors weighing on the lira.
A potential sharp interest rate hike?
Wall Street analysts at JPMorgan and Goldman Sachs expect the lira to continue to fall, but a lot will depend on whether the central bank hikes interest rates or introduces capital controls. JPMorgan predicts that with the central bank getting a new head in the coming days, there will be a super-sized hike up to 25%-30% from the current 8.5%.
However, a super sharp interest rate hike could bring the Turkish economy to a halt or tip it into recession. This could be offset by a drop in the lira which could boost tourist season and support spending on reconstruction after February’s destructive earthquake.
A falling lira will reignite worries over a fresh rise in inflation, which on Monday as data showed it fell to below 40% but is expected to rise to 50%.
Lira has depreciated by 7%
Due to boom-and-bust cycles and frequently high inflation, the Turkish Lira has experienced a depreciation of around 7%, and its value declined by more than 90% throughout the past decade. The recent victory of President Erdogan has further contributed to a negative sentiment among economists and FX strategists regarding the future prospects of the lira.
Turkish Lira and Erdogan’s view on interest rates
Following the currency crisis in 2021, Turkish authorities have taken on an increasingly active role in FX markets, resulting in abnormally small daily fluctuations that mostly indicate a weakening trend. This intervention has occurred alongside a decline in foreign exchange and gold reserves.
Many global media have predicted a sell-off of the Turkish lira in the period following the elections, regardless of whether Erdogan won or not. While there are expectations by market participants and economists that interest rates will rise significantly, finance minister Nuruddin Nabaty dispelled such hopes. The CBRT will meet next on the 22nd of June and markets have priced in a 25 basis points hike.
Despite Turkey’s high inflation levels, the central bank has lowered rates since October last year, and this is because Turkey’s monetary policy focuses on economic growth and export competitiveness rather than controlling inflationary pressures. Erdogan is also a firm believer that higher interest rates mean higher inflation.
Turkish Lira forecast: Will it decline further?
Wells Fargo believes that the economic and markets outlook for Turkey is gloomy, while JP Morgan warned that it will take very long to bring inflation down and that the central bank should also focus on building FX reserves. They stated that only by returning to orthodox macroeconomic policies, would the lira start to appreciate.
Further weakness beyond 2023
Market participants expect the Turkish lira to weaken further.
USD/TRY: analysts expect the lira to reach record lows by the end of June and move lower by next year. With Turkey’s unorthodox monetary and economic policies in place, analysts expect the lira to maintain its weakness. A lot will also depend on the relationship between the US and Turkey. Currently, the USD/TRY hit record highs and is partly supported by negative sentiment towards the re-election of President Erdogan, especially after Turkey kept a neutral position in the war in Ukraine.
EUR/TRY: The euro has strengthened but the lira is forecast to rebound and trade higher by the end of this year.
GBP/TRY: The pair is anticipated to stabilise, with the lira rising slightly.