Turkish lira firms ahead of expected rate hike – Forex News Preview

Raffi Boyadjian, XM Investment Research Desk

Turkey’s central bank is widely expected to raise interest rates on Thursday, with a decision due at 11:00 GMT. The Turkish lira has advanced to two-week highs versus the US dollar in anticipation of much needed action by the Central Bank of the Republic of Turkey (CBRT), which has come under attack by investors for not doing enough to stem the lira’s freefall. Turkey’s large current account deficit makes the lira particularly vulnerable to capital outflows, as recently highlighted by the wider turmoil in emerging market economies.

The Turkish currency first came under pressure during the country’s presidential election in June when President Recep Tayyip Erdogan insinuated he would tighten his grip on monetary policy should he get re-elected. According to Erdogan, interest rates are the “mother of all evil” and has repeatedly called for lower borrowing costs. However, with inflation rising fast and reaching a 15-year high of 17.9% year-on-year in August, the CBRT has little option but to tighten monetary policy.

Inflation was, ironically, initially fuelled by an overheating economy, which the central bank failed to bring under control, resulting in the loss of investor confidence in the CBRT. But following the diplomatic spat with the United States in August that resulted in President Trump imposing sanctions on some Turkish ministers and doubling tariffs on steel and aluminium, the lira’s slide accelerated, pushing up inflation and driving the country to a full-blown currency crisis. The lira is down by over 40% versus the US dollar in the year-to-date.

The CBRT is expected to raise its one-week repo rate to 22.00% from 17.75% on Thursday, with forecasts ranging from 20% to 25%. Additional steps are also likely after the central bank said it “will take the necessary actions to support price stability” in a statement following the release of the August inflation data last week.

If the CBRT increases rates as expected, dollar/lira could decline to around the 23.6% Fibonacci retracement of the downleg from 7.2149 to 5.6565, which is just above the psychological 6.00 handle. A smaller-than-forecast move could warrant more moderate losses to around the 6.25 level, which is the 38.2% Fibonacci retracement. On the other hand, a surprise bigger-than-anticipated hike could trigger a sharper rally for the lira, pushing dollar/lira to the August swing-low of 5.6565.

However, given the CBRT’s history of disappointing, especially when under political pressure, dollar/lira could reverse some of the past week’s declines if investors aren’t impressed by the bank’s actions on Thursday. The pair could initially rise towards the 50% Fibonacci at 6.4357, with a climb above this level opening the way to the 61.8% Fibonacci at just below the 6.62 level. A breach of the 61.8% Fibonacci would weaken the near-term positive momentum for the Turkish currency and turn the focus for dollar/lira back to the upside.

In the event the CBRT is unable to restore confidence, by possibly announcing only a modest rate hike and/or failing to signal further monetary tightening, the lira could see a resumption of the recent sharp sell-off. Dollar/lira could head back towards its all-time high of 7.2149, with a break above that high bringing into range the 161.8% Fibonacci extension at 8.1780 as the next key resistance.