Turkey may pay a high price for its failure to maintain central bank credibility in investors’ eyes.

By unexpectedly holding rates on Tuesday, policy makers fueled investor fears that monetary policy under President Recep Tayyip Erdogan’s watch will remain too loose to contain price pressures. While markets clawed back some ground on Wednesday, there’s a danger Turkey could see the kind of rout that forced the central bank to raise rates aggressively earlier this year.

Risk reversals, the premium traders pay for options to sell the lira compared with those to buy, climbed to the highest since 2016 on a closing basis on Tuesday, slightly above levels that preceded a 300-basis point emergency rate increase in May. The fear is that even higher import prices may feed into a weaker lira and reinforce expectations for a hike before the central bank’s next scheduled meeting on September 13.

“Here we go again,” said Inan Demir, an economist for emerging markets at Nomura Plc. “An emergency hike seems to be the only way out of this loop.”

The last time Turkey boosted borrowing costs at an emergency meeting came after Erdogan, who has long opposed interest-rate increases, said he intends to take more responsibility for monetary policy if he was re-elected. His comment, together with an emerging-market rout, helped put the lira on course for its worst month in about a decade.

Turkish assets plunged on Tuesday after the central bank kept a key interest rate unchanged in the first monetary policy decision since Erdogan’s re-election. Concern over his rising influence in the nation, his unorthodox views on monetary policy and the country’s twin deficits have dragged the currency down the most in the world this quarter. It handed carry traders the biggest loss this year after Argentina’s peso.

“Turkey is likely to head into a serious confidence crisis before the government rethinks its policies,” said Shamaila Khan, AllianceBernstein’s director of emerging-market debt in New York. “Our view on Turkey is that things will get worse before they get better.”

Source : www.bloomberg.com