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Turkish lira hits record low after bank holds rates

Turkey's central bank held its key interest rate on Tuesday, as mounting political and military concerns push the Turkish lira to record lows.

The central bank left its main rate unchanged at 7.5 percent, as forecast by economists polled by Reuters.

The Grand Bazaar in Istanbul, Turkey
Kerem Uzel/Bloomberg via Getty Images
The Grand Bazaar in Istanbul, Turkey

After the decision, the lira hit its weakest ever level against the dollar, falling as low as 2.8850, having traded at 2.8675 beforehand.

In a statement, the central bank said a backdrop of falling food and energy prices, plus domestic and global market uncertainty had factored in its decision.

"Processed food and energy price developments affect inflation favorably in the short run, while exchange rate movements delay the improvement in the core indicators," it said.

"Considering this delay and taking into account the uncertainty in domestic and global markets and the volatility in energy and food prices, the Committee decided to implement a tighter liquidity policy as long as deemed necessary."

The bank added that future monetary policy decisions would be "conditional on the improvements in the inflation outlook."

"Inflation expectations, pricing behavior and other factors that affect inflation will be monitored closely and the cautious monetary policy stance will be maintained... until there is a significant improvement in the inflation outlook."

Right decision?

Whether the decision to hold is the right one or not is a moot point, however.

"If a 12 percent slide in the lira versus the dollar since mid-May, a core inflation rate that is still two and half percentage points above the central bank's 5 percent target and an increasingly bleak external backdrop for emerging market assets do not force Turkey's central bank to adopt a significantly more hawkish stance, then this begs the question: what on earth will?" Nicholas Spiro, head of Spiro Sovereign Strategy, said in a note after the announcement.

He added that the message for markets from the bank's inaction was "very troubling."

Pressure is mounting on the bank to act to stem market jitters and the sliding currency, in part due to the country's uncertain political outlook and the rising risk of a snap election.

Investor sentiment has also been hit by Turkey's military action in Syria, targeted at Islamic State militants.

Read MoreTurkey: A former emerging market star stumbles

Rising risk of snap election

Since the start of the year, the lira has weakened by nearly 25 percent, with the currency pressured further since June when inconclusive elections in Turkey left the incumbent Justice and Development party (AKP) without a parliamentary majority.

Since then, tense negotiations have taken place between opposition parties but no coalition has been formed, raising the likelihood of fresh elections and more uncertainty for investors.

Ahead of the rate decision on Tuesday, Prime Minister Ahmet Davutoglu, who leads the AKP, said he had exhausted all options to form a government with the nationalist MHP party and that he would meet with President Tayyip Erdogan to discuss the next steps.

Erdogan could call a snap election if a deadline to form a coalition by August 23 is not reached.

Pressure on the central bank

While raising interest rates could help stem the lira's slide, the central bank is under pressure from the government to cut rates in order to stimulate Turkey's flagging economy—although the bank is supposedly fully independent from political influence.

On Monday evening, Turkey's economy minister, Nihat Zeybekci, said that while he did not expect a cut this week, Turkey's benchmark borrowing costs should be lowered, according to Reuters.

Read MoreTurkey central bank still beholden to politics?

Ben Gutteridge, head of fund research at Brewin Dolphin, told CNBC that Turkey needed to loosen monetary policy in order to stimulate growth, but that doing so would be problematic while the lira was falling.

"They don't have the flexibility that they need at this time," he said on Tuesday.

"The idea that they can start loosening monetary policy, which is what their economy needs in terms of growth, is very unlikely given the challenges that their currency faces and what that brings in terms of inflationary pressure and currency weakness," Gutteridge added later.

- By CNBC's Holly Ellyatt, follow her on Twitter @HollyEllyatt. Follow us on Twitter: @CNBCWorld