Turkish central bank might deliver its first rate hike in nearly three years this week in a bid to defend the lira, which has seen a series of record lows over the past month. Expectations for such a move are building up after the central bank was given the green light by the government's economic coordination committee, which met on November 18.   

Rate setters have been under has been under pressure from President Recep Tayyip Erdogan to lower the borrowing costs to stimulate the slowing economy. The bank slashed its overnight interest rate by 250 basis points since March even as inflation remained above target.

In the meantime, however, the lira has lost over 14% of its value against the dollar since the start of the year as investors test the central bank's resolve amid the widespread assumption that the bank won’t use its strongest tool to defend the lira. The bank will hold a rate setting meeting on November 24. 

Turkish Prime Minister Binali Yildirim called a meeting of the economic coordination committee on November 18 after lira hit to a new record low of 3.4085 earlier in the day. Turkish central bank closely monitors economic developments and it will take necessary measures to support financial stability, the committee said in a press release after the five-hour long meeting.

Central bank governor Murat Cetinkaya was also present at meeting. All measures taken by the central bank have so far failed to stop the lira’s slide.

Markets perceived the committee’s reference to the central bank as a green light for a policy rate hike. However, some analysts argue that the central bank may delay the rate hike and may just refer to a possible hike in the coming months.

The committee will hold another meeting on November 22 and it will again discuss fluctuations in the domestic currency. Turkish lira was trading at 3.3775 against the dollar as of 13:30 Istanbul time, up 0.07% d/d, while the benchmark BIST-100 index was down 0.21% d/d.

Policy rates has long been a political debate in Turkey after Erdogan started last year to argue that high interest rates were harming the country’s growth performance. Over the last year, Erdogan, Yildirim and other members of the cabinet have reiterated many times the government’s argument for policy rate cuts. Erdogan has not commented yet on rising expectations for a policy rate hike.

A recent survey held by Reuters even before the recent committee's meeting showed that analysts from local brokerage houses expect Turkish central bank to hike its main policy rate, one-week repo rate, by 25bp.

At the latest rate setting meeting held on October 20, the central bank decided to keep all three of its main interest rates unchanged helping the lira recover from record losses suffered earlier in the week. Most analysts initially predicted a 25bp cut in the overnight (ON) lending rate. But following statements from Erdogan's top aides hinting at a pause in the easing cycle, investors changed their expectations, betting that the bank would keep the rates on hold.

The bank’s monetary policy committee left the ON lending rate unchanged at 8.25%, the main policy rate (one-week repo rate) was kept at 7.5% and the overnight borrowing rate at 7.25% at the October 20 meeting. This was the first time in eight months the bank did not cut the upper end of its interest rate corridor, ON lending rate.

The recent slide in the Turkish currency has been driven by rising rising expectations for an interest rate hike by the US FED next month. Turkey is one of the most vulnerable countries in the emerging world to higher Federal Reserve interest rates because it relies on capital inflows to finance its large current account deficit. Higher US borrowing costs make emerging markets assets less attractive.

The lira has also been under pressure from rising domestic political and economic risks.  Purges and arrests in the wake of the July 15 coup attempt as well as the crackdown on pro-Kurdish opposition party HDP have been going on. There is almost no mainstream opposition media left after the executives and writers of the leading opposition newspaper Cumhuriyet were arrested.

Renewed push towards the introduction of an executive presidency system and discussions for the return of the death penalty are back on the Turkish government’s agenda amid the turbulence in the financial markets. Moreover, geopolitical risks related to the ongoing conflicts in Syria and Iraq continue to impose significant security risks to the Turkish economy. The rift with EU, Turkey’s main economic partner, has also been deepening. 

Erdogan reiterated on November 20 that Turkey should not see its EU accession bid as the only option it has. Rather it should discuss alternatives like Russia-led Shanghai Pact.