The lira trades above the 25 mark as central bank fails do win back credibility

The Turkish central bank raised its key rate for the first time since 2021. However, the hike by 650 bp raising the one-week repo rate to 15% is disappointing as many market participants hoped for a much stronger move to kickstart a long-awaited return to more orthodox policies. On Friday, just a day after the decision USD/TYR breached the 25,0 mark for the first time in history.

Gradual tightening might not be enough to convince the world that Turkey is determined to shift its course towards permanent crisis and macroeconomic instability and restore the credibility of the Turkish authorities, which has long been in tatters in the eyes of investors. On a broader horizon, however, the key question for Turkey, which is gradually being pushed to the margins of the international financial world, is how much patience Erdogan will have with the difficult path of market reforms.

In May, President Recep Erdogan secured a continuation of Turkey's two-decade-long rule. Since the second round of elections, the lira, which had previously been stabilised by a series of interventions that had cost 200 billion USD and restrictions on the freedom of capital flows, has collapsed sharply. The USD/TRY reached new historic highs, and the 20% jump in the exchange rate was the steepest lira depreciation episode since 2021. That collapse indirectly exacerbated the destabilisation of the Turkish economy and the surge in inflation to a record 86% y/y last autumn, and no response would have risked anything like this happening again.

Turkey's president has remained unchanged, but there have been a number of reshuffles in the power camp. These involve not only the minister of finance but also the head of the central bank. Both key positions have been given to Turkish bankers who have had careers in foreign financial institutions. Investors believe that the appointment of Hafize Gaye Erkan as head of the monetary authority heralds a break with an extremely mild monetary policy that exacerbates imbalances and is ill-suited to the complex economic situation. A year ago, interest rates in Turkey were at 19%. Despite inflation running at tens of percent, Erdogan, who was seeking re-election then, pushed through cuts to the 8.5% level that has been in place since February.There is little doubt that a turn towards more orthodox policies requires a sharp increase in the cost of money to cool the economy, bring inflation under control and stabilise the lira.