CBRT Likely To Remain On Hold This Month

But Upside Risks Remain

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The dramatic decline in the Turkish Lira has been the headline move in currency markets this year with TRY having fallen by over 30% against the US Dollar as inflation spiraled out of control, last peaking at nearly 25%, as geopolitical tensions began boiling over.

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6.25% Interest Rate Rise

However, following aggressive action by the CBRT last month which hiked the main interest rate by a massive 6.25%, TRY has recovered some of its losses against the Dollar, stabilizing investor sentiment somewhat after a long, tumultuous summer of volatility.

Further Rate Hike This Month?

The CBRT is due to meet again this week, with the market wondering whether we are going to see further policy action to consolidate the gains made.  However, given the massive policy adjustment in September, as well as the release of US Pastor Brunsen, which has caused a huge de-scaling of geopolitical risk, it seems more reasonable to expect the CBRT to keep its powder dry for now, especially while the effects of the September hike are still being felt so strongly. TRY has been the highest yielding emerging market currency over the last month, thanks to the CBRT’s swift response and improved investor sentiment which likely allows the CBRT some breathing room this time around.

US Considers Lifting Sanctions

Statements from the US regarding the potential lifting of sanctions on Turkey following the release of Pastor Brunsen have hugely improved the geopolitical risk profile as well as a more compromising tone from the US regarding Turkey reducing its imports of Iranian crude ahead of fresh US sanctions on Iran in November.  These latest developments will be a strong boost to the country’s capital flow outlook.

Improvement in external imbalances has also been boosting TRY sentiment with a sharp reduction in domestic demand for imports leading to a current account surplus in August, marking the first surplus since September.

Inflation Still The Key Threat

However, the issue of inflation is still a major concern for the CBRT. The latest CPI data in September was far stronger than expected with the annual figure jumping to 24.5% from 17.9% over the prior month, marking the biggest monthly increase since the 2011 financial crisis. Core inflation was similarly orbital, moving to 24% from 17.2% over the previous month due to the pass-through from the sharp decline in TRY over the year.

Considering the widespread pick up in prices which saw increases in all major price categories alongside the continuing impact of the sharp decline in TRY this year, the potential for CPI to rise further over the year is very much alive, keeping inflation risks to the upside for the CBRT. With this in mind, the prospect of a further rate hike this time around cannot be ruled out.

Inflation Forecasts Revised Higher

The CBRT’s latest expectations survey projects year-end inflation to hit 24.22% from the prior estimate of 19.61% in September. Furthermore, 12-month and 24-month targets have also risen with the former moving up to 17.03% (highest 12-month forecast since 2003) and the latter moving up to 12.7% (an all-time high for 24-month forecasts).

Given the stabilization in geopolitical risks as well as the strong recovery in TRY against USD, it seems more likely at this stage that we will see a hawkish hold from the CBRT which is expected to acknowledge the upside risks from inflation and reaffirm the bank’s willingness to act aggressively where necessary.

Technical Perspective

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For now, USDTRY continued to retreat with TRY approaching the 50% retracement of its peak against USD at the start of the year. The 5.4210 level (50% retracement) and the 5.0154 level (61.8% retracement) will be key levels to watch if USDTRY continues to move lower with a break of the latter level marking a distinct shift in sentiment on the pair. Until this level is taken, the current moves can be seen as corrective with the likelihood of further upside still intact.

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