Turkey's currency fell to historic lows on August 27 as the head of the central bank disappointed investors with comments that he's "relaxed" about the lira's level and would continue to use the bank's reserves - rather than interest rates - to prop up the struggling currency.
Central Bank of Turkey Governor Erdem Basci said in an interview with the state-run Anadolu news agency that he had rescheduled his summer vacation to deal with a currency that has plunged more than 13% against the dollar since the start of the year. Investors are worried about a toxic combination of simmering anti-government protests, regional conflict, upcoming elections, critical imbalances in the slowing economy and a "tapering off" of the US Federal Reserve's vast money-printing operations.
Economists had been expecting Basci to take the opportunity to reassure investors the central bank is ready to hike rates or normalize its unorthodox policy to shore up the currency. Turkey's central bank has been tightening monetary conditions to support the lira using a range of untypical tools - on August 20 it increased the overnight lending rate by half a percentage point to 7.75% and it has spent $8.3bn of reserves in currency auctions since early June - but has left its main benchmark rate unchanged at 4.5%.
But instead, Basci insisted the central bank "won't step back on interest rates," and would use the roughly $80bn in reserves it has. The drop in the lira, he believes, is only temporary. "We are not concerned about the exchange rate... We think the depreciation of the lira is temporary," Basci was quoted by newswires as saying in the interview. "You may even see the lira below 1.90 against the dollar later this year - this is highly probable."
Unsurprisingly, the lira fell over 1% against both the dollar and euro following the interview. The dollar surged past 2.03 lira for the first time, while the euro rose to a record high of 2.7163 lira, according to newswires.
Timothy Ash, head of emerging market research at Standard Bank, told CNBC that the central bank's approach is "strange" and Basci was "tearing up the central banking rule book" with his unorthodox policy. "He seems to be taking away one of his few bullets in the gun by not allowing himself the option of not using interest rates," he told CNBC, adding that the situation had become "high risk". The large current account deficit for Turkey and external financing requirements meant the lira would continue to be biased towards weakness, he said.
Basci is believed to be hemmed in by the government, which is facing a series of elections over the coming year and doesn't want to see economic growth choked off by higher interest rates.
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