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Düsseldorf, Frankfurt The Turkish lira is currently under severe pressure on the financial markets. It has suffered the largest price losses so far this year in October and has depreciated by around 8% against the euro alone. During the year, their losses amounted to over 44% against the euro and over 37% against the dollar.
The lira therefore finds itself in the middle of a dangerous downward spiral from which economists see no easy way out. “There is no rational answer as to how far the lira can still go down,” said Tatha Ghose, Commerzbank foreign exchange expert. In his view, the central bank could try to break the downward momentum with a major emergency rate cut. Even then, however, he believes the chances of success are uncertain.
An important reason why investors lose faith in the lira is the issue of central bank independence. Turkish President Recep Tayyip Erdogan is a proponent of low interest rates. Many investors fear its influence on the central bank. Last year he fired the then head of the Turkish central bank. His successor lowered interest rates, as requested by Erdogan. In June 2019 they were still at 24%, currently they are at 10.25%.
Interest rate cuts tend to support the economy by offering businesses and consumers cheaper credit. However, they are negative for the exchange rate of the relevant currency. If interest rates drop in Turkey, it becomes relatively more attractive for international investors to invest their capital in other currency areas, which weakens the exchange rate of their own currency.
A falling lira rate also increases inflation because it makes imports more expensive. Despite the drop in oil prices, inflation in Turkey is still very high. Commerzbank expects it to rise to 16% by the end of the year.
Is the central bank lowering interest rates further?
Another big problem in Turkey is that many companies and even the state have taken out loans in foreign currencies, mainly euros and dollars. If the lira falls against these currencies, the weight of their debts increases. This creates the risk of a downward spiral where the collapse of the currency and the weakness of the economy reinforce each other.
There was already a severe currency crisis in Turkey in 2018, in which the lira came under severe pressure. At that time, the Turkish central bank was able to stop the decline with drastic increases in interest rates. However, this came at a high price: the result was a severe recession, i.e. a shrinking economy. Turkish President Erdogan then pushed for lower interest rates and fired the then head of the central bank in summer 2019.
Since then, the Turkish central bank has drastically cut interest rates. On the one hand, this has strongly stimulated the economy. On the other hand, the current level of the interest rate is considered too low to stabilize the exchange rate of the lira.
The question now is whether the central bank is ready to raise interest rates again. Furthermore, the impact may be less this time around if investors question the sustainability of such a move in light of the 2018 experience.
More: The precious metal does not protect against the collapse of the currency
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