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Following bigger than expected interest rate rise, Turkish lira remains volatile

Turkey's Central Bank Governor Erdem Basci speaks during a press conference in Ankara, Turkey, Tuesday, Jan. 28, 2014. The bank is signaling that it is preparing to reverse course and raise interest rates to address higher inflation and a dropping currency. The bank was holding an extraordinary meeting Tuesday and was expected to announce higher rates in a statement overnight.(AP Photo)

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Turkey's Central Bank Governor Erdem Basci speaks during a press conference in Ankara, Turkey, Tuesday, Jan. 28, 2014. The bank is signaling that it is preparing to reverse course and raise interest rates to address higher inflation and a dropping currency. The bank was holding an extraordinary meeting Tuesday and was expected to announce higher rates in a statement overnight.(AP Photo)

ANKARA, Turkey - Bold action by Turkey's central bank gave the national currency only a brief lift as investors worried that aggressive interest rate increases may not work in bringing an end to the market volatility.

Analysts said concerns over political stability and more stimulus reductions by the U.S. Federal Reserve mean the future remains murky for Turkey and the lira. Above all, they say raising interest rates to defend a currency is a blunt instrument that can only be used so many times without causing considerable damage to an economy.

"These interest rate moves have bought temporary relief but the history of using interest rates to defend a currency usually ends in tears," said Neil MacKinnon, global macro strategist at VTB Capital. "Turkey's rate hikes, for example, will be regarded as unsustainable and unrepeatable."

In early afternoon trading, the Turkish lira was down 2.3 per cent against the dollar at 2.2296 Turkish lira. That means it is more or less back where it was when the central bank surprised markets earlier with its announcement that it was raising its main overnight lending rate to 12 per cent from 7.75 per cent and more than doubling its one-week rate to 10 per cent from 4.5 per cent.

The Turkish lira has hit record lows in recent weeks on concerns over global growth, the prospect that a police bribery scandal might destabilize the government, and the change in the monetary policy stance of the U.S. Federal Reserve.

Turkey, like other emerging economies, has seen an influx of foreign investment over the past few years as the Fed and other central banks have pumped the prime to shore up their economies. Now that the Fed has begun the process of reducing its stimulus, much of that money is expected to be withdrawn.

"We still expect the lira to remain under downward pressure in the year ahead as external financing conditions tighten," said Lee Hardman, currency strategist at Bank of Tokyo-Mitsubishi UFJ. "Heightened domestic political uncertainty still poses downside risks as well to the lira."

A big worry is that higher borrowing rates will make a big dent in Turkey's economic activity. Many economists think growth will more or less halve this year to 2 per cent. That helps explain why the Turkish stock market reversed earlier gains to trade 1.2 per cent lower.

The action by the central bank came in the face of pressure by the Turkish government, which wanted rates to remain low in order to shore up growth. One of the reasons behind the turmoil afflicting Turkey's financial markets was the decision by the central bank to keep policy unchanged on Jan. 21 despite rising inflation. Analysts said the decision was likely due to government pressure.

Ahead of the decision, Prime Minister Recep Tayyip Erdogan reiterated his view that he was opposed to any interest rate hike while insisting that he respected the central bank's independence.

"It is their decision, I have no authority," he told reporters. "Of course the responsibility is theirs as well. They will be responsible and will have to account for whatever may arise tomorrow."

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Pylas reported from London.

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