August 7, 2018 / 12:38 PM / 12 days ago

Turkey's lira, bonds hit again on U.S. trade threat, central bank worries

ISTANBUL (Reuters) - Turkey’s lira held close to its record low against the dollar on Tuesday as concerns deepened about a rift with the United States and President Tayyip Erdogan’s influence over the central bank.

The currency had fallen as much as 5.5 percent on Monday to 5.4250 per dollar, an all-time low and its biggest intraday drop in nearly a decade, after Washington said it was reviewing access to the U.S. market for Turkey’s exports.

It slipped in and out of negative territory on Tuesday and was trading at 5.3035 to the dollar TRYTOM=D3 and 6.1535 per euro EURTRY at 1201 GMT (8.01 a.m. ET). Turkey's 10-year benchmark bond yield hit 20.09 percent, the highest on record.

The depth of the sell-off reflects growing unease about the direction of monetary policy under Erdogan, a self-described “enemy of interest rates”, and the impact of worsening ties with the United States, a NATO ally and major trading partner.

The lira’s chronic weakness — it is down 27 percent on the dollar and 26 percent against the euro year-to-date — has driven inflation to nearly 16 percent and fueled expectations that an emergency rate hike may be needed to prop it up.

“The plunge in the currency over the past few weeks is now on a scale which has, in the past, prompted the central bank to hike interest rates aggressively,” William Jackson of Capital Economics said in a note to clients.

“The lira’s fall is being amplified by concerns that the central bank will not act to shore up the currency.”

The central bank raised interest rates to support the lira in an emergency move in May, before a re-elected Erdogan assumed new executive powers that investors fear will compromise its independence.

He wants lower borrowing costs to fuel credit growth and economic expansion. Economists say the economy is overheated and needs higher rates.

The central bank’s apparent reluctance to hike has heightened concerns about its ability to act independently of the president, who appointed his son-in-law Berat Albayrak as treasury and finance minister last month.

U.S ROW

The row with the United States has only served to further undermine sentiment among foreign investors, upon whom Turkey relies to fund its widening current account deficit.

A Turkish foreign ministry source said a delegation led by new deputy foreign minister Sedat Onal would go to Washington to discuss the row between the NATO allies, which the U.S. Embassy in Ankara said maintained solid political and economic ties.

Broadcaster CNN Turk said the delegation would include three officials apiece from the justice, finance and foreign ministries and would hold its first meeting on Wednesday.

Relations have been strained by differences over Syria, and the trial in Turkey of U.S. evangelical Christian pastor Andrew Brunson for allegedly supporting the group Ankara blames for an attempted coup in 2016. Brunson denies the charge.

The United States is seeking the release from detention of three locally employed embassy staff.

At the weekend, the U.S. Trade Representative said the United States was reviewing Turkey’s duty-free access to its markets, after Ankara imposed retaliatory tariffs on U.S. goods in response to American tariffs on steel and aluminum. The move could affect $1.7 billion of Turkish exports.

The spat has further hammered the lira, which lost nearly a quarter of its value last year, even after a cut to the upper limit of banks’ reserve requirements that the central bank said on Monday would provide lenders with $2.2 billion of liquidity.

“In an environment where the market expects an interest rate hike, the central bank only changed reserve requirements,” said economist Mahfi Egilmez on Twitter.

“The lira plunged as markets got the impression that the central bank has problems hiking rates. It would have been better if they did not change the reserve requirements at all.”

NO HEADLINES

Erdogan, who has previously cast lira selling as the work of Western financiers attempting to bring Turkey to its knees, has been notably quiet about the crisis this time around. Last week, he called on Turks to convert hard currency and gold into lira and said Turkey would turn to Chinese markets for financing.

Local media made almost no mention of the currency crisis on Tuesday.

The lira’s plunge has sharpened investor concern about the outlook for Turkish companies, which may struggle to repay some $223 billion of debt they have raised in dollar and euros.

Credit ratings agency Moody’s has predicted problem loans will rise to well above 4 percent in the next 12-18 months, from 2.9 percent from May, which would also be costly for banks.

Goldman Sachs meanwhile warned that a further drop in the lira could wipe out Turkish banks’ capital buffers.

Turkish stocks were up half a percent. The BIST index of blue-chip stocks is down 40 percent in dollar terms this year, according to Thomson Reuters data — second only to Venezuela as the worst performer among some 30 emerging market stock indices.

A money changer counts Turkish lira banknotes at a currency exchange office in Istanbul, Turkey August 2, 2018. REUTERS/Murad Sezer

Additional reporting by Tulay Karadeniz and Tuvan Gumrukcu in Ankara and Birsen Altayli in Istanbul; Writing by David Dolan; Editing by Catherine Evans

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