Turkish lira reverts to volatile type

Turkey’s lira, the second worst performing currency of 2016, reverted to type with a bout of volatile trading after the country’s central bank kept interest rates unchanged.

After strengthening by nearly 1 per cent ahead of the meeting, the lira came back under pressure and was trading at around TL3.54 to the dollar, although another bout of volatility subsequently pushed it higher in late London trading.

Concerned about the currency’s slump and the country’s struggling economy, the central bank defied pressure from president Recep Tayyip Erdogan and raised rates last month in the first increase since 2014.

However, the lira has remained weak and hit an all-time low of TRL3.5840 in early December amid political worries and a rising oil price.

A majority of economists surveyed by Bloomberg expected the central bank to hold borrowing costs today.

Political tensions are rattling EM investors more broadly. The assassination on Monday of Russia’s ambassador in Ankara hit appetite for EM assets, according to Maxim Korovin of the Russian bank VTB Capital.

So far this year, the lira has fallen 17.5 per cent, a plunge eclipsed only by the Argentine peso among major and emerging market currencies. In the last month alone, the lira has fallen 4.7 per cent.

Its record low touched on December 2 could be breached, according to Brown Brothers Harriman’s strategist Win Thin, because of investor disappointment at the central bank’s latest decision.

“We had hoped that recent lira weakness would push the bank into hiking rates again. However, we know that the bank is under pressure not to tighten further,” said Mr Thin.

“With the lira remaining weak and oil prices rising, we think price pressures are likely to pick up and will ultimately require further tightening in 2017 as well.”

A rate rise was the most efficient tool available to the central bank to stabilise the “battered” lira, said Piotr Matys, EM strategist at Rabobank, but policymakers were under political pressure not to tighten monetary conditions.

Other tools deployed include President Erdogan’s entreaty to Turks to buy liras or gold. But while such measures offer some respite, “the currency is not out of the woods just yet”, Mr Matys said.

Turkey’s lira is an extreme example of the pressures facing EM currencies, which are ending the year as they began 2016 — weakening under the weight of a Federal Reserve rate rise and a strong dollar.

The US central bank last week raised interest rates for only the second time since the financial crisis. While that move was widely forecast, policymakers in Washington surprised some investors and traders by projecting a more aggressive path of tightening in 2017.

According to the central bank’s latest projections released last week, it will raise rates three times next year. That is up from a September projection of just two increases.

Next year will bring the added complication for EM currencies of a trade policy that if Mr Trump’s campaign rhetoric is anything to go by, will leans towards protectionism.

Malaysia’s ringgit is one EM FX currency which has enjoyed the benefits of free trade and productivity but is likely to be hit by shifts in US trade policy. It hit its lowest level since the 1998 Asian crisis, declining to MYR4.4790 to the dollar.

“The weak investment sentiment is driven by its vulnerability to capital outflows given the high foreign ownership of government bonds, relatively weak reserves buffer, concerns over the reinstatement of capital controls and lingering political uncertainties,” said Commerzbank analyst Kai Wei Ang.

Jeremy Cook, chief economist at payments provider World First, said a combative US and a strong dollar would put pressure on Singapore, South Korea and other parts of the EM universe that have relied on US funding and a free and easy trading environment, as well as Indonesia and Malaysia.

The president-elect represents “an almost existential risk to trade”, said Mr Cook.