Turkish lira firms, analysts doubt central bank firepower

The Turkish currency, the lira, firmed in early trading on Tuesday, having rallied on Monday after the central bank intervened on the foreign exchange market.

The lira was being traded at 1.9498 to the dollar during trading on Tuesday.

On Monday it had fallen to a record low level of 1.9740 to the dollar.

On the government debt market, Turkey's 10-year borrowing rate eased slightly but remained high at 8.80 percent compared with 8.93 percent late on Monday.

The central bank sold dollars to shore up the Turkish currency, as it announced urgent and "strong" action on Monday to defend the lira and clamp down on overheated lending by the financial sector.

The central bank had opened seven foreign exchange auctions on Monday, selling a total of $2.25 billion, Finansbank said.

At Capital Economics in London, chief emerging markets economist Neil Shearing commented that "the scale of yesterday's intervention by the Turkish central bank to defend the lira underlines the vulnerabilities that have built in the country's economy."

He noted that the lira had fallen by about 10.0 percent against the dollar since the beginning of May, and that inflation in June was 8.3 percent compared with the bank's year-end target of 5.0 percent.

He said that the markets had responded to the intervention in a "muted" way, perhaps because the central bank's "firepower is limited."

Official foreign exchange reserves stood at about $120 billion but this included $45 billion of currency reserves owned by commercial banks. Net reserves, after removing other items, amounted to about $45 billion.

Turkey's heavy need for external financing "requires that interest rates are kept high in order to attract capital inflows" but the government was putting pressure on the bank to keep rates low to support growth.

Shearing argued that "the lira is likely to fall further over the next year or so" and interest rates were likely to rise and this was likely to result in weaker growth, he commented.

The central bank said on Monday that it would pursue the new measures for as long as the lira was under pressure.

But market analysts were immediately sceptical that this policy, which involves using up foreign currency reserves, would be enough to shore up the lira for long and avert an increase in official short-term interest rates.

They said that the main factor putting the lira under pressure was the prospect that the US Federal Reserve bank would begin to wind down its special injections of money to stimulate the US economy.

This had caused an outflow of some risk investment funds from emerging economies, and the Turkish lira had been hit particularly hard, they said.