Turkish lira slightly weaker ahead of key rate decision

ISTANBUL: Turkey's lira weakened slightly on Thursday ahead of the central bank's rate decision, where it is expected to hike its policy rate by 100 basis points to 18%, in what is seen as a key test of its commitment to bringing inflation down.

The expectations of a hike rose this month after the lira lost as much as 10% since mid-February, as the yields on US Treasury bonds increased. Inflation also rose more than expected to nearly 16% last month.

The lira stood at 7.4930 against the dollar at 0540 GMT, slightly weaker than Wednesday's close of 7.4860.

The currency came under renewed pressure after a top prosecutor filed a case demanding the closure of the pro-Kurdish Peoples' Party (HDP), the country's third largest political party, but later pared losses.

Since his appointment in November, Central Bank Governor Naci Agbal hiked the policy rate by 675 basis points and has promised more tightening if needed.

Thursday's meeting is seen as a test of whether Agbal, who has also promised tight policy for an extended period, can turn his hawkish words into action given President Tayyip Erdogan's opposition to high interest rates.

All 21 economists polled by Reuters expected a hike to the one-week policy rate this month.

A rate hike is necessary for Agbal to prove he can move independently from Erdogan, said Atilla Yesilada, economist at Istanbul Analytics.

"If there isn't a 100 basis point rate hike, it will open the way for a very dangerous flaming up of the exchange rate."

Yesilada added that the case for the HDP's closure could lead to a deterioration in US-Turkey ties, as the United States said the move would undermine democracy in Turkey, and further pressure the lira.

Lira's depreciation can lead to higher import costs, risking further raising inflation, which the central bank expects to drop to 9.4% by year-end.

A hike would help maintain the central bank's credibility but it could also increase political pressure to cut rates in coming months, said Emre Peker, a director at Eurasia Group whose coverage includes Turkey.

"With a hike, Agbal will be firing his last bullet, then the challenge will be maintaining a tight policy long enough to combat inflation."