News in Charts: Lira steadies on hopes for return to orthodox central banking

Türkiye’s currency, the lira, has lost substantial value against the US dollar in recent weeks. The currency had slowly depreciated in the run-up to elections in May, but fell more swiftly since. Ahead of the first round of voting near the middle of the month, USDTRY was trading at 19.6. Following a successful result in a second round of voting in late May for the incumbent president, Recep Tayyip Erdogan, the lira has dropped to record lows with USDTRY at 23.7 on June 15.

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Türkiye’s central bank seemed to use its resources to prop up the lira ahead of the election, with its net international reserves position dropping from $27.5 billion to $6.8 billion between the start of 2023 and the eve of first round voting. This position has declined even further since, dropping below zero for the first time since records began in 2020. Without central bank reserves to defend the currency, the lira has been easy prey for short-selling speculators. The result has been a large depreciation.

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Without substantial reserves, the central bank is left with interest rates as its primary tool to defend the currency’s value. Higher short-term interest rates would help to keep domestic savers from transferring money abroad and could attract inflows from outside the country as well. However, for some time, the country has pursued an unorthodox monetary policy approach that has seen interest rates decline even against rapidly rising inflation. This is in contrast to the textbook approach to monetary policy, where higher inflation prompts central bankers to set higher interest rates in order to contain and then suppress price pressures.

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News of a new central bank governor has helped to stabilise the currency – at least for now. Hafize Gaye Erkan was appointed as the first female governor of the country’s central bank. With a PhD from Princeton and a long career in the US, including at Goldman Sachs, there is a feeling in markets that she and the newly appointed Finance Minister Mehmet Simsek will adopt a more traditional approach to monetary policy. Indeed, Türkiye government bond yields have increased since the election, suggesting investors are starting to price in interest rate hikes. The new governor’s first policy announcement is due on June 22.

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A widely regarded truism, in economics as in life, is that there is no such thing as a free lunch. In this case, higher interest rates, were they to transpire, might help to stabilise and even strengthen the currency while lowering inflation. However, they would also risk delivering a negative hit to credit and wider economic growth. Such an outcome would threaten what has been a very strong recovery from the pandemic for Türkiye. Nonetheless, it is likely to be a pill worth swallowing: low and stable inflation is widely seen as a necessary, if insufficient, condition for long-term prosperity.

The views expressed in this article are the views of the author, not necessarily those of Refinitiv Lipper or LSEG.

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