Is this the tipping point for the Turkish lira?

The Turkish lira has lost 90% of its value in the past decade. To turn the tide, the Turkish central bank has ditched its low interest rate policy and raised its key rate sharply today. However, more is needed for a sustainable recovery of the lira.

Almost everywhere in the world, central banks have raised interest rates in recent years. This is a tried and tested means of controlling rising inflation. Higher interest rates make it more expensive for households and businesses to borrow money, reducing spending and investment. Experience shows that it is better to accept the cooling down of the economy and the associated risk of recession, rather than letting inflation run rampant. For years, Turkey was an exception to the rule. President Recep Tayyip Erdogan was convinced that with the support of low interest rates, the economy would get itself out of trouble. After an extremely painful decade, the country is now opting for a different interest rate.

Big interest rate increase
At 11am this morning, newly appointed central bank president Hafize Gaye Erkan announced that the key interest rate would be raised from 00% to 8,5%. In response, the lira fell by 15%. A very large rate hike is not unique. At the end of February last year, for example, the Russian interest rate suddenly went from 3% to 9,5%. At the time, this happened in response to the invasion of Ukraine, which initially caused a major blow to the Russian ruble. In the period that followed, the Russian currency was able to recover, which was largely due to higher income from energy exports as a result of the high oil price. That tailwind must miss the lira.

Will Erkan get the space?
The Turkish currency has lost more than 90% of its value compared to the euro in the past decade. It remains to be seen whether Erkan will be given the space by Erdogan to structurally put an end to that free fall. Today's interest rate hike is no coincidence. From an economic point of view, Turkey has painted itself into a corner that something had to be done. Although inflation has fallen slightly from the 85% recorded in October last year, it is still above 40%. Moreover, currency reserves have fallen rapidly in recent months as the central bank used them in a doomed attempt to support the lira.

Argentina as a specter
If Turkey had continued on its chosen path, it could just follow Argentina. Inflation there has risen to 114%. Despite the fact that the policy rate has been raised from 2022% to almost 40% since the beginning of 100, the central bank is unable to rein in inflation and restore public confidence in the peso. As an emergency measure, Argentina is considering exchanging its own currency for the US dollar. It is clearly not that far in Turkey for the time being. But it is vital that today's interest rate hike really is the beginning of a policy turn, rather than a one-off emergency move. Incidentally, this ensures that the currency world is now looking at the lira with much more tension and less resignation than in the past decade.

Joost Derks

Joost Derks is a currency specialist at iBanFirst. He has over twenty years of experience in the currency world. This column reflects his personal opinion and is not intended as professional (investment) advice.

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