Turkish lira hits fresh record low following US sanctions

Key Points
  • Turkish lira hits all-time low versus the U.S. dollar.
  • The emerging market currency recovers some ground as inflation data beats forecast.
  • Analysts doubt the Turkish central bank's independence from President Erdogan.
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 tumbled to a new record low overnight following U.S. imposed sanctions relating to the trial of an American pastor accused of backing terrorism.

The new sanctions on Thursday were placed on two of President Tayyip Erdogan's ministers, with the U.S. saying they played a leading role in the arrest and detention of evangelical pastor Andrew Brunson.

He's charged with supporting a group blamed for an attempted coup in 2016. U.S. Secretary of State Mike Pompeo is expected to meet Turkey's top diplomat at the ASEAN summit Friday.

The lira hit an all-time low of $5.1125 versus the dollar shortly before midnight Thursday eastern time. Mildly better-than-expected Turkish inflation data released Friday morning provided brief respite and at around 8:00 a.m. ET the currency had risen back to $5.0700.

Inflation in the country has been rampant with consumer prices rising almost 16 percent in July alone. While the country's central bank has raised interest rates to support the currency and quell inflation, the Central Bank of Turkey unexpectedly held its benchmark interest rate at 17.75 percent on July 24. Erdogan has repeatedly insisted that rates should not be raised too high, triggering suggestions that the central bank doesn't act with full independence.

A banner of Turkish President Tayyip Erdogan.
Chris McGrath | Getty Images

Peter Kinsella who acts as the director of rates and FX strategy at the Commonwealth Bank of Australia said Thursday that the lira has been under pressure for several years due to rising inflation.

Kinsella told CNBC by phone that Turkey's real interest rates, which are adjusted for inflation, now sit at just 1 percent and that isn't high enough to stabilize a depreciating lira. He said supporting the currency would need a sustained period where rates, when including for inflation, offered a greater return.

"The central bank needs to give a credible commitment to maintaining a very large positive real interest rate spread for at least 18 months to 2 years," said Kinsella.

The analyst said, however, that this was historically not a typical course of action for a central bank that tended to cut rates as soon as there was any evidence of price stability.

Kinsella added that few investors believe Erdogan will grant the central bank sufficient autonomy to raise rates, but he predicts that some foreign capital will stay invested in underlying Turkish assets as long as they are deemed cheap and rewarding.

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

Turkey's economy is seen as particularly fragile due to its high level of debt that is priced in dollars. The more the lira weakens, the more expensive that debt becomes. The latest estimates from the International Monetary Fund show that the total amount of Turkish debt payable in other currencies is more than 50 percent of the country's gross domestic product.

Luis Costa, head of CEEMEA FX and rates strategy at Citibank, told CNBC'S "Squawk Box Europe" Thursday that while his bank remained a seller of Turkish lira, it was less to do with U.S. sanctions or Turkish domestic policy and more related to "rising U.S. real yields which makes some currencies particularly vulnerable."