Petrotahlil - Turkish policymakers are no strangers to unexpected action when in a tight corner, but analysts said Thursday's surprise interest rate hike could herald a change of tack on monetary policy.
Although raising rates by 200 basis points during a global pandemic and slump is unusual, analysts welcomed the Central Bank of Turkey's (CBT) response in the face of rising inflation.
"It was a bold move by the CBT which should restore credibility and improve investor sentiment," said Christian Wietoska at Deutsche Bank, calling it a "game changer".
The hike was swiftly followed by a banking watchdog announcement that limits for banks' FX transactions with foreign entities would be raised, allowing for increased market access and reversing a decision from earlier this year.
"Encouraging moves - suggests the Turkish authorities finally get it," Timothy Ash at BlueBay Asset Management said.
Turkey has frequently squeezed offshore currency markets and its President Recep Tayyip Erdogan sees foreign investment in Turkish financial markets as a hotbed of speculation and has lambasted high interest rates.
The central bank said on Thursday that it hiked its policy rate after a fast recovery from the initial coronavirus shock sent Turkish inflation higher than expected.
Thursday's actions were small steps in restoring confidence, which has been sapped by restrictions on offshore lira markets that have seen trade volumes shrivel in London.
"The answer to foreigners trying to sell lira is not make it harder to sell, as this just encourages people to get out while they can and will deter them coming back," Ash added.
Although Turkey's hike takes its benchmark rate to 10.25% and pulls interest rates level with 12-month inflation expectations, analysts expect Ankara will have little choice but to ramp up interest rates to 12% by year-end.
"The rate needs to be 100 or 200 basis points above inflation – then we can get much more structurally constructive on the lira," Tatha Ghose, FX & EM analyst at Commerzbank, said.
Turkey will also need to cement its commitment to tackling inflation and returning to a more orthodox monetary policy, though this comes at a difficult time after its economy contracted nearly 10% in the second quarter and is expected to shrink in 2020 as a whole.
"Unless this is seen as a permanent situation, that the monetary experiment of cutting rates to lower inflation rates is over, unless that happens it will not work anyway – it will just be a temporary relief (for the lira)," Ghose said.
In the run up to the central bank meeting, Erdogan had voiced his support for lowering rates, he added.
While the battered lira enjoyed a rare bounce in the wake of the interest rate hike, most of the gains faded quickly, showing investor scepticism about how this will filter through into financial market rates, the need for further moves and how sustainable it can be in the already ailing economy.
The lira is one of the worst performing developing currencies so far in 2020 and has more than halved in value in just three years.
And rising redemptions of corporate foreign exchange loans in October and November combined with very low FX reserves could put fresh pressure on the Turkish currency, Citigroup's Dirk Willer said.
The International of Institute Finance estimates that private sector external loan repayments amount to nearly $10 billion in the coming two months.
Latest data showed net FX reserves have slipped to $18.8 billion and Goldman Sachs estimates Turkey has burnt through nearly $80 billion in 2020 on propping up the lira.
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