Turkish bond yields hit record low on rate cut hopes

Comments on Thursday by Economy Minister Zafer Caglayan that the real exchange rate stands in an "excessive appreciation zone" supported the rate cut prospects, analysts said.

The lira eased and the main share index was down, led by banking shares.

The yield on Turkey's two-year benchmark bond hit its lowest ever level of 5.63 percent, down from Wednesday's close at 5.73 percent. It has fallen around 20 basis points this week.

By 1001 GMT, the lira weakened to 1.7686 to the dollar , after earlier hitting its weakest since late January of 1.7715, from 1.7646 late on Wednesday. Against its euro-dollar basket it weakened to 2.0837 from 2.0764.

"Investors pricing in a cut of 25 basis points by the central bank in its overnight borrowing rate in February, so the front end of the yield curve is falling. The trading volume is thin," wrote Tufan Comert, strategist at Garanti Securities in a research note.

"However, the long-term bond yields rise in line with external markets and inflation expectations.

The yield on the 10-year bond stands close to 7 percent," he added.

The yield on the bond maturing on Sept. 14, 2022 stood at 6.94 percent on Thursday, compared with last week's close at 6.74 percent.

After ratings agency Fitch upgraded Turkey to investment grade in November, the central bank repeatedly said it was appropriate to keep rates low as capital inflows accelerate, suggesting it was trying to deter destabilising inflows and avoid excessive appreciation of the lira.

Rate cut expectations rose after the lira's real effective exchange rate had risen above the threshold of 120 at which policymakers have said they would react.

A higher real exchange rate, which indicates the currency's strength, would widen Turkey's already large current account deficit by making exports more expensive and imports cheaper.

Istanbul's main share index was down 0.49 percent at 79,662 points, led by a fall of 0.9 percent in banking shares and underperforming a fall of 0.26 percent in the global emerging markets index.

"Investors expect the central bank to raise reserve requirements, as loan growth stood above the bank's comfort zone. This creates a sell-off pressure on banking shares," wrote Fatih Keresteci, strategist at Garanti Securities.

At the presentation of its quarterly inflation report on Jan. 29, the central bank said its assumptions were based on annual loan growth of 15 percent.

Banking sector annual loan growth stood at 17.6 percent as of Jan. 25, according to Reuters calculations based on Turkish banking sector watchdog (BBDK) data.

The central bank last month reduced its overnight borrowing rate to 4.75 percent from 5 percent and its lending rate to 8.75 percent from 9 percent. It also raised reserve requirements to control rapid loan growth.