The British pound (GBP) to Turkish lira (TRY) exchange rate reached a three-month high in September. Forecasts from J.P. Morgan, MUFG and Goldman Sachs suggest it could rise further, with possible record highs next year or sooner.
GBP/TRY rose to 12.15, its highest level since late June. The rise followed the Central Bank of the Republic of Turkey’s (CBRT; Turkish: Türkiye Cumhuriyet Merkez Bankası (TCMB)) announcement on 23 September that the country’s interest rate would be cut from 19% to 18% – a policy decision that dealt the lira a heavy blow.
In a note by Muhammet Mercan, chief economist for Turkey at ING, we learn that regarding the timing of a rate cut, the CBRT had reiterated that “the current stance will be maintained until the significant fall in the Inflation Report’s forecast path is achieved”. He adds: “The market was not expecting a move this month.”
September’s rate cut was widely seen in the market as the first in a likely cycle of cuts. It’s rankled with investors and analysts because of Turkey’s high inflation rate - 19.25%, as of 3 September.
While the GBP’s losses pulled GBP/TRY back below 12.0 in the final week of September, few analysts see the TRY recovering by much or for very long if the CBRT does go on to reduce its interest rate further.
Some analysts have seen bearish forecasts realised sooner than expected. New record lows could be in store for the TRY over the three-to-six months from September if the CBRT cuts borrowing costs too far or too fast in the intervening period.
GBP/TRY analysis: What’s driving the FX pair?
Central bank policy burden
While there are many factors that can impact the lira and GBP/TRY, none is more significant than the CBRT’s interest rate policy, which the market perceives as being under the influence of President Recep Tayyip Erdogan.
“It seems that despite high inflation data, the TCMB could not hold off the influence of President Erdogan on monetary policy, dealing another blow to the bank’s credibility and undermining investor confidence in Turkish assets,” said Eirini Tsekeridou, a fixed income analyst at Julius Baer, writing in a September research note on behalf of Switzerland’s oldest private bank and wealth management firm.
President Erdogan’s beliefs about inflation and approach toward the CBRT have seen no less than four Governors fired since 2018, with the latest in March 2021 when Nagi Acbal was replaced by Sahap Kavcioglu days after a CBRT decision to raise the cash rate from 17% to 19%.
Ankara’s idea is that rising interest rates leads to rising inflation and vice versa, which reflects a school of thought described in some circles as a “neo-fisherite rebellion”.
What matters most for the lira is that the market has lost confidence in the authorities’ ability to control price pressures.
“Recent communication from the central bank and the government, as well as the earlier-than-expected start to the easing cycle on 23 September, suggest that bringing inflation under control is not a short-term policy priority,” said Melis Metiner, a CEEMA economist at HSBC.
“Our base case scenario going forward is for the CBRT to lower the policy rate to 16% by the end of this year and further to 11% by the middle of 2022,” Mertiner added.
The unorthodox approach to inflation, personnel changes at the CBRT and earlier interest rate cuts have contributed to repeated bouts of currency depreciation that have lifted GBP/TRY and USD/TRY by an annual average of more than 35% since January 2018.
The March 2021 changing of the guard at the CBRT was instrumental in lifting GBP/TRY and USD/TRY nearly 20% for 2021 by late September – and September’s interest rate cut has put the market on notice that further reductions in borrowing costs could follow.
Cross rate dynamics
The pound to lira rate is a currency cross rate. CBRT policy is the lira’s dominant driver, affecting GBP/TRY through its impact on USD/TRY
Cross rates reflect changes in value of two currencies after each is measured against the dollar – interbank level market makers tend not to trade the GBP against the TRY or any other non-dollar currencies against other non-dollar currencies.
“The practice within the market is to quote all currencies against the US dollar; this reduces the number of individual rates that need to be quoted. The exchange rate between any two non-dollar currencies is calculated from the rate for each currency against the dollar,” the Bank of England explained in its quarterly bulletin of December 1980.
The above bulletin came after the world moved to a system of free-floating exchange rates that have since been determined largely by market supply and demand for currencies that are traded mainly against the dollar.
One effect of this system is that GBP/TRY tends to only respond to the relative moves in TRY/USD and GBP/USD – another effect is that up and down moves in USD/TRY tend to provoke similar movements in GBP/TRY. Likewise with GBP/USD and GBP/TRY.
The pound turkish lira chart below shows how a twist or a turn in either of USD/TRY or GBP/USD can be enough to turn the tide for GBP/TRY. In this instance, GBP/TRY had been rising alongside USD/TRY until being pulled lower in late September when losses in GBP/USD became larger than those being suffered by the lira.
What are analysts saying?
Analysts tend not to produce much GBP/TRY commentary, but because of the above cross rate dynamics their forecasts for USD/TRY also imply sterling to lira predictions, while analyst commentary on USD/TRY is an integral part of the pound to lira news agenda.
Many forecasts had already envisaged record highs for USD/TRY and knock-on effects for GBP/TRY even before the CBRT reduced its interest rate in September, but some analysts now suggest the lira could fall even lower and sooner than was previously thought.
“USD/TRY is likely to hit our Q2 2022 forecast of 9.2500 much sooner,” said Lee Hardman, a currency analyst at MUFG, in a 23 September note to clients. “We expect the TRY to remain under selling pressure going forward. The earlier than expected CBRT rate hike has brought forward our forecasts.”
Mitsubishi UFJ Financial Group (MUFG) had tipped USD/TRY to see out 2021 at 8.65, and combining this with the bank’s GBP/USD forecast of 1.4040 made for a pound to lira exchange rate forecast of 12.14.
Both of these projections were realised in the wake of September’s rate cut. The bank said in the final week of September that GBP/TRY and USD/TRY could reach their second quarter 2022 forecasts much sooner, though without specifying exactly when.
J.P. Morgan also says that September’s rate cut “brings forward risks for the currency”.
“Even with relatively contained assumptions on policy rate cuts (100bps in the last two months of the year, bringing the policy rate to 17% and then additional 200bps of cuts with the policy rate stable at 15% after), the real rate profile becomes rather worrying,” said Anezka Christovova, an analyst at J.P. Morgan, in a 24 September note.
“This is especially the case given the potential for the Fed to start raising its policy rate late in 2022.”
Christovova said the CBRT would need to offer a positive ‘real’ interest rate that is higher than those available from other currencies in order for the lira to keep its head above water, but warned that September’s rate cut makes this unlikely.
J.P Morgan’s forecasts for USD/TRY and GBP/USD had implied an expectation that GBP/TRY would end 2021 at 11.56 and that 12.15 would be seen by March 2022, but each of these projections were also realised before the end of September.
The Wall Street company’s other forecasts have GBP/TRY reaching a new record high of 12.83 in June 2022, with USD/TRY rising to 9.50 over the same time period.
Goldman Sachs’ forecasts are particularly bullish for GBP/TRY.
“While spot moves in USD/TRY since Thursday’s TCMB meeting have avoided extremes, this is not indicative of underlying FX risks: in recent years policymakers have made use of an extensive toolbox to attempt to contain FX depreciation in times of stress, and they are likely to employ these tools going forward,” warned Kamakshya Trivedi, co-head of global foreign exchange, interest rate and emerging market strategy at Goldman Sachs.
Trivedi and colleagues told Goldman Sachs’ clients in a 24 September note that recent increases in USD/TRY and underlying losses for the lira may be misleadingly small because the CBRT tends to intervene in the market in hope of limiting the lira’s decline.
They say that “risks are skewed firmly to the upside” of forecasts for USD/TRY to reach 9.00 and 9.50 in three and six-months respectively, which means there may also be upside risks to three and six-month forecasts of 12.69 and 13.87 for GBP/TRY.
Those would be record highs for each exchange rate, but with more upside in GBP/TRY.
“Given the overall tone of the meeting, we think that the authorities have likely begun their cutting cycle. Our terminal rate forecast remains unchanged at 15%, but we now think that this rate will be reached in mid-2022 (rather than end-2022, previously),” Trivedi said.
“Overall, this week’s events have continued to increase both our and investors’ concerns around policy credibility and macroeconomic risks in Turkey.”
Note that analyst predictions are often wrong. You should always conduct your own research before making any investment or trading decision.
Where next for GBP/TRY?
The outlook for TRY depends on if and how far the CBRT cuts interest rates, and how the inflation outlook develops in the interim.
The March 2022 GBP/TRY rally reflected speculation that newly appointed Governor Kavcioglu would quickly reverse the 2% increase in the cash rate to 19% that was announced under his predecessor Agbal, in acquiescence to Ankara.
“We had previously expected the lira to strengthen this year and Turkish assets to gain ground. But that view was predicated on the assumption that the recent shift in Turkey’s policymaking towards more aggressive inflation fighting – of which the appointment of Mr Agbal was an integral part – would last,” wrote Franziska Palmas, a markets economist at Capital Economics, in a 22 March note to clients.
“The events over the weekend have made clear that this won’t be the case. Indeed, the removal of Mr Agbal so soon after the CBRT’s decision to hike interest rates by a larger-than-expected 200bp [base points] last Thursday points in the opposite direction,” Palmas added.
It wasn’t until this September that Governor Kavcioglu’s CBRT actually made a move. Even then the cut announced so far has been small compared with past reductions, but it has still pushed inflation-adjusted interest rates - known as the ‘real rate’ - below zero and negatively affected analysts’ perceptions of the lira’s value.
“A more deeply negative real policy rate leaves the TRY vulnerable to further weakness,” MUFG’s Hardman said.
“The CBRT’s decision to begin lowering rates when the headline inflation rate is still elevated at 19.25% has cast fresh doubt on monetary policy credibility in Turkey amidst President Erdogan’s continued calls for lower rates.”
Turkish inflation rose from 18.25% to 19.58% in September, leaving it far above the CBRT’s 5% target and at a level that would have ruled out an interest rate cut under the bank’s May 2021 commitment to keep borrowing costs above the main rate of inflation.
That commitment was not repeated in September’s announcement, suggesting it has been abandoned after being repeated in each of June, July and August’s policy decisions.
This was the closest thing investors had to an assurance that interest rates would remain high enough to eventually counter the elevated rates of inflation seen in Turkey, and without it there’s less telling when or by how much interest rates could be cut.
“The rapid recovery in global demand, the high course of commodity prices, supply constraints in some sectors and the increase in transportation costs cause producer and consumer prices to rise on an international scale,” the CBRT said, according to the meeting minutes.
For its part the CBRT cited an August decline in the core inflation rate - which excludes energy and food prices - as evidence that recent increases in inflation are global in nature and not something that Turkish central bank monetary policy can address.
Nonetheless, the rate cut has sent a negative signal to the market about the outlook for interest rates and the lira, leading analysts to bring forward forecasts suggesting that both GBP/TRY and USD/TRY are set to further extend their steep and long-term uptrends.
Reasons to be Long GBP/TRY
The decision to go trade must be based on your own analysis and evaluation. You should consider technical analysis and fundamentals. Here are some reasons that may support the decision to go long on GBP/TRY:
GBP/TRY is sensitive to movements in USD/TRY, and this latter exchange rate is widely expected to rise further in the months ahead now that the central bank has begun what many perceive as likely to be a cycle of interest rate cuts.
Both GBP/TRY and USD/TRY have risen by more than 35% on average in the years since January 2018 in response to personnel changes at Turkey’s central bank and policy decisions that have led its interest rate to be set at levels the market deems as too low.
Inflation has risen in Turkey and across the world. It’s possible that further increases will be seen, which could lead the CBRT to come under political pressure to cut interest rates further than it might have otherwise.
Whether you go long or short is your decision. Always remember that your decision to trade depends on your attitude to risk, your expertise in this market, the spread of your investment portfolio and how comfortable you feel about losing money. Never invest money you cannot afford to lose.
Reasons to be Short GBP/TRY
The decision to go short must be based on your own analysis and evaluation. You should consider technical analysis and fundamentals. Here are some reasons that may support the decision to go short GBP/TRY:
GBP/TRY did not reach new record highs in tandem with USD/TRY in September due to weakness in the main sterling exchange rate GBP/USD, and it’s possible that both exchange rates could fall further in the weeks and months ahead due to factors unrelated to Turkey and its monetary policy.
Turkish authorities are known to intervene in the currency market and it’s possible they could be successful in averting any fresh losses for the lira. If such a defence coincides with further weakness in GBP/USD then it could lead GBP/TRY to fall.
September’s -1% interest rate cut was smaller than the +2% increase announced in March 2021. It’s possible that further reductions will also be smaller and slower to materialise than analysts now expect.
Whether you go long or short is your decision. Always remember that your decision to trade depends on your attitude to risk, your expertise in this market, the spread of your investment portfolio and how comfortable you feel about losing money. And never invest money you cannot afford to lose.
Edited by Jekaterina Drozdovica
Analyst forecasts widely suggest that GBP/TRY will rise over the coming months and through much of 2022. The only meaningful difference in views centres around how quickly and how far the lira will fall.
Investors and traders should note that analyst forecasts can be wrong. Forecasts shouldn’t be used as a substitute for your own research. Always conduct your own due diligence before investing. And never invest money you cannot afford to lose.
Optimum timing would depend on whether a trader goes short or long on GBP/TRY. The currency market is open 24 hours a day, five days a week. The GBP/TRY can be traded between Sunday at 22:00 BST to the same time on Friday.
However, the largest share of foreign exchange trading is carried out in London during European hours, which means foreign exchange market liquidity and trading volumes are generally at their highest during then.
Generally speaking, short trades are most profitable when entered at the highest possible price level and vice versa with long trades, although traders should make their own decisions on when to buy or sell any asset or product, following their own process of research and evaluation.
The main difference between CFD trading and trading assets, such as commodities and stocks, is that you don’t own the underlying asset when you trade on a CFD.
You can still benefit if the market moves in your favour, or make a loss if it moves against you. However, with traditional trading you enter a contract to exchange the legal ownership of the individual shares or the commodities for money, and you own this until you sell it again.
CFDs are leveraged products, which means that you only need to deposit a percentage of the full value of the CFD trade in order to open a position. But with traditional trading, you buy the assets for the full amount. In the UK, there is no stamp duty on CFD trading, but there is when you buy stocks, for example.
CFDs attract overnight costs to hold the trades (unless you use 1-1 leverage), which makes them more suited to short-term trading opportunities. Stocks and commodities are more normally bought and held for longer. You might also pay a broker commission or fees when buying and selling assets direct and you’d need somewhere to store them safely.