In a previous post, we refereed to depositors losing confidence in lira. This has been the main reason behind the weakness of lira. Because it is clear that there has not been any capital outflow enough to cause a dramatic decline in lira, it was the jump in residents’ foreign exchange deposits that has destabilized the currency.
Low rates that generate negative real returns has been the key driver of this phenomena. In my opinion Turkish Central Bank’s hike will be helpful tool to stem lira fall. Interest rates around 10% will return 2%-2,5% in real terms while inflation expectations hang around 7,5%. At the last monetary policy committee Turkish Central Bank gave a very clear message that tight monetary policy stance would be sustained until there is a significant improvement in the inflation outlook. In other words Turkish Central Bank will keep rates high enough to provide real returns even if it will do some damage on economic growth. This is the only sure way to stabilize the currency and bring inflation, running above 7%, down to a 5%target, otherwise the switch in to foreign currency will add pressure on lira, inflation, and eventually on economy.