Turkish lira caught in the crosshairs

The sharp fall in the Turkish lira already this year, and the disappointing response by the central bank, have prompted us to revise our currency forecast down. We now see it ending the year at 4.00/$ (previously 3.75/$) and 2018 at 4.25/$ (4.00/$ before). If anything, the risks may be skewed to the downside. The Turkish lira has regained some lost ground this week, but it has still depreciated by over 7% against both the euro and the dollar since the start of the year – the worst performance of any EM currency. There are several drivers behind the lira’s fall. Turkey’s large external financing requirement makes it vulnerable to higher US interest rates. But the sell-off has been exacerbated by domestic political risk (parliament recently approved putting constitutional amendments that would strengthen the presidency to a referendum) and concerns that the MPC would bow to political pressure not to raise rates.