Turkish markets saw something of a rally last week, but the economy still seems headed for a severe recession, according to Capital Economics.

Markets rallied amid signs of improving foreign relations and easing strains in the banking sector, with the Turkish lira (TRY) one of the best performing emerging markets currencies in the week, strengthening by around 5% against the dollar, the macroeconomic research company said in a September 28 note. The TRY made more gains on October 1, trimming losses against the dollar by 1.60% d/d to place it at 5.9712.

Meanwhile, the stock market last week staged a recovery—the Istanbul stock exchange’s benchmark BIST-100 index moved above 100,000 for the first time since the end of May. Government bond yields dropped back.

“There are a couple of factors behind this rally,” Jason Tuvey at Capital wrote. “One is hopes of improved foreign relations. President [Recep Tayyip] Erdogan is currently in Berlin seeking to mend ties with the German government. He has also made some more conciliatory remarks towards the US and there are suggestions that detained US Pastor Andrew Brunson, who has been at the centre of the recent row between the two countries, will be released in the coming days.

“Second, strains in the banking sector appear to be easing. Earlier this week, the country’s second largest bank, Akbank, secured a $980mn syndicated loan – an encouraging sign that banks are still able to access wholesale financing. In response, banks’ bond spreads have narrowed.”

However, observed Tuvey’s note, the positive news flow has been somewhat overshadowed by the release of more dire economic data.

August’s trade data showed that imports fell by 10.6% y/y (in working-day adjusted terms), a sign that domestic demand has weakened sharply. “And Turkstat’s Economic Confidence Index plunged from 83.9 in August to 71.0 in September which, on past form, is consistent with GDP contracting by around 10% y/y,” added Tuvey. “This supports our view that the economy is entering a deep recession and our GDP growth forecasts lie well below the consensus.”