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ISTANBUL: The lira weakened to record lows against the dollar and euro on Monday after Moody's downgraded Turkey's rating to 'B2' from 'B1' late last week and warned of a deeper economic crisis.

The ratings agency said Turkey's external vulnerabilities are likely to result in a balance of payments crisis and that its fiscal buffers were eroding as the agency cut the sovereign rating deeper into junk territory.

The lira touched a record low of 7.4980 against the dollar, bringing its losses so far this year to nearly 21%. The currency hit an all-time low of 8.9031 against the euro, weakening 25% since end-2019.

"Turkey's prospects have materially weakened. The possibility of a funding shock continues to be the key risk facing the Turkish economy," said Ehsan Khoman, head of MENA research and strategy at MUFG Bank.

He said it was especially worrying that Moody's kept a negative outlook on Turkey even after the downgrade.

The ratings agency said FX reserves versus GDP were at lows not seen in decades due to the central bank's unsuccessful attempts to defend the lira this year.

Turkey's dollar-denominated government bonds fell, with some losing more than 1 cent on the dollar. Credit default swaps rose 4 basis points from Friday to 513.

Nonetheless, expectations remain low that the central bank will raise its policy rate at a meeting next week. It could continue backdoor tightening steps that have raised the average cost of funding to 10.29% on Friday, from around 10.15% where it had steadied last week.