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Central bank averts lira’s freefall, for now

The Turkish lira recovered on Wednesday after the central bank reassured the market that monetary tightening would continue until inflation improves, but experts said on Wednesday that pressure on the lira will remain amid the prospect of a rate hike in the United States.

The currency hit record lows on Tuesday due to an emerging market sell-off and domestic political tensions. Turkish Central Bank Governor Erdem Başçı said on Wednesday the bank would keep its monetary policy tight until there was a clear improvement in the inflation outlook. One US dollar traded slightly above 2.35 against the lira on Wednesday, down from Tuesday’s record low of 2.41.

The central bank sets interest rates monthly, but is able to tweak the average cost of funding for banks through daily repo auctions, and foreign-exchange auctions can help impact the exchange rate. The average cost of funding rose to 8.85 percent on Tuesday from 8.79 percent on Monday, owing to daily tightening from the central bank. But analysts warned that the central bank’s pledge on Tuesday to meet some of the foreign exchange needs of state energy importers may not be effective in the medium term.

“[If] deterioration in global risk appetite continues and leaves the lira exposed to further depreciation, this action will be rather ineffective,” a note from Finansbank said. It added that the bank was expected to raise the amounts of daily forex sales and push up overnight interbank rates to defend the currency. The lira stood at 2.369 against the dollar at 1006 GMT, having touched 2.414 on Tuesday, its weakest ever in an emerging market slide spurred by a collapsing ruble with domestic political tensions amplifying the impact on the lira.

Investor sentiment towards Turkey soured this week after Sunday’s arrests of media executives from outlets critical of the government. President Recep Tayyip Erdoğan on Monday rejected EU criticism over the arrests and signaled that more raids could come.

Turkey’s main stock index was almost flat at 79,200 points, outperforming the emerging market index, which fell 0.19 percent. The 10-year benchmark bond yield inched up to 8.77 percent from 8.76 percent at Tuesday’s close. Markets eyed the US Federal Reserve’s last policy meeting of the year with expectations that the rate-setting committee of the world’s biggest economy would drop a commitment to keeping rates low for a “considerable period” and possibly raise the interest rate by mid-2015. A hike in US interest rates would attract funds from emerging markets with a promise of a higher return than before and lower risk — making it more expensive for Turkey to fund its large current account deficit (CAD).