It is common knowledge that a key rate hike positively affects a currency rate. But Turkey has its own magic rules, not only when it comes to ice cream salesmen. The increase in interest rate collapsed the lira to unexplored depths. Let’s investigate how this could have occurred.
After the presidential elections in Turkey, another significant event took place. Having worked in Goldman Sachs and First Republic Bank, Hafize Gaye Erkan assumed the role of the new governor of the Central Bank of Turkey. Prior to her appointment, Turkey had an extravagant economic policy aimed to beat double-digit inflation with a low interest rate, allegedly stimulating economic growth.
The traditional approach of combating inflation involves interest rate hikes. Typically, the value of a currency tends to rise – we can see this trend in various currency pairs, EUR/USD for example. The chart below illustrates the outcomes of Turkey's alternative approach to tackling inflation.
When inflation reaches 85%, it can be an indication that something is going wrong. In other words, changes were long overdue, and many experts expected that the new head of the central bank would adopt a different strategy. Well, it happened. The Turkish regulator raised the interest rate by 6.5% – the current rate is 15%.
While to someone it may seem substantial, the truth to be told, it’s not. Analysts were anticipating a bigger hike, ranging from 20% to 40%. “Not enough”, decided market participants, disappointed by the outcome, causing the value of the lira to decline further and reach new lows.
Why didn't this happen earlier? Two words – currency interventions. The Turkish government regularly used this method to support the lira, and in the end, the currency reserves turned out to be depleted.
Therefore, we got a combination of two factors – the disenchanted market and the ceasing of currency support. Both of them are not working in the lira’s favor.
Simultaneously, the Central Bank of Turkey reported that this interest rate hike would not be an isolated occurrence. The regulator plans to maintain such a policy in the nearest future. It should be beneficial for the lira (in theory), but the problem lies in the generally poor conditions of the Turkish economy right now. Addressing these issues will require not months, but years.
Due to these circumstances, analysts don’t expect a change of trend for the USD/TRY currency pair any time soon. Moreover, the lira will likely continue its fall downward, potentially reaching 30 liras per US dollar within the next 12 months or even before the end of this year.
It is important to remember that blindly trusting expert opinions is risky – every successful trade requires your own analysis. Market conditions change swiftly, and experts are prone to making mistakes. So, it’s essential to do research before buying or selling anything in the Forex market or any other market.