Buying the Turkish lira is like ‘catching a falling knife,’ strategist warns

Key Points
  • The Turkish lira continued its downward spiral after the country's central bank left interest rates unchanged, reinforcing investor fears over the bank’s independence.
  • Investors see Turkish president Recep Erdogan as wielding too much control over monetary policy while allowing inflation to skyrocket.
  • The lira fell 4 percent Tuesday, hitting 4.9377 against the dollar. It was hovering around 4.8170 at 3:00 pm Istanbul time on Thursday.  
Fake US Dollar and Turkish Lira currency often used as a novelty gift is seen for sale at a tobacco shop in a market on December 5, 2016 in Istanbul, Turkey.
Chris McGrath | Getty Images

The Turkish lira plunged this week after the Central Bank of the Republic of Turkey (CBRT) left interest rates unchanged Tuesday amid spiking inflation.

The surprise move reinforced investor fears over the bank's independence, leading one strategist to liken buying the currency to "catching a falling knife."

The beleaguered currency has lost as much as 20 percent of its value against the U.S. dollar this year.

"As far as the lira is concerned — well, as the old saying goes, don't catch a falling knife," Neil Mellor, senior currency strategist at BNY Mellon, told CNBC Thursday. Asked if there was any near-term scope for recovery, Mellor wasn't optimistic.

"It's difficult to see a silver lining at present because the recent rise inflation has been fairly dramatic, and some signs of stabilization will be necessary before the market can heave a sigh of relief."

The lira lost 4 percent of its value Tuesday, hitting 4.9377 against the U.S. dollar as the central bank left rates at 17.75 percent, contradicting analyst expectations of a hike of at least 100 basis points (bps). It later stabilized to 4.8750 or 3 percent lower versus the dollar. It was hovering around 4.8170 at 3:00 pm Istanbul time on Thursday.

Investors see Turkish President Recep Erdogan, who recently won re-election to a new and more powerful executive presidency, as wielding too much control over monetary policy while allowing inflation to skyrocket.

Erdogan has long prioritized rapid economic growth over countering the country's inflation, now at an unsustainably high 15 percent. That marks the highest level since January 2004 and far exceeds the central banks stated target of 5 percent.

Erdogan, who's called himself the "enemy of interest rates," furthered fears that central bank policy would be beholden to the executive by installing his son-in-law Berat Albayrak as finance minister.

But Albayrak publicly stated he would "not fight the markets," giving investors hope that policy would be guided by economic convention rather than politics. The decision to hold rates, then, came as a shock to many.

The CBRT justified itself by saying it was seeing faster re-balancing in the economy, a point many market analysts dispute.

"The facts are the June inflation print rose over 300 bps in year-on-year terms, and the CBRT does nothing, so how can a credible central bank suggest that it cares about inflation?" asked Tim Ash, senior emerging markets strategist at Bluebay Asset Management, via email Tuesday.

And Mellor described the "self-feeding circular mechanism that is inflation and currency weakness" as a daunting prospect that will only continue to scare away investors. "I think the bottom line is that the market needs to see something assertive from the authorities to break the mechanism."

Analyst: Turkey's government needs to prevent a hard-landing in the economy