EUR struggles to hold gains

During the Asian session, the US dollar extended yesterday’s gains but quickly lost its advance as risk sentiment continued to improve. After sliding to $1.1655, the single currency bounced back towards the 1.17 threshold. It is going to be a big week for the single currency as Mario Draghi is much awaited by market participants. The European Central Bank governing council will gather this week in Frankfurt to discuss monetary policy. As usual, the attention will focus on the council’s view of the economic outlook as well as inflation development. Since the June meeting, investors have reviewed there expectations to the downside and do not expect the ECB to hike interest rate before at least summer 2019.

Looking at the euro price developments, the single currency has most likely bottomed out this year as US rates struggle to keep upside momentum. Therefore, the $1.1510 would most likely remain the lowest level seen this year. Even though further euro appreciation appears the most likely scenario, the uncertainty generated by the trade war could cap those potential gains. The area’s composite purchasing manager index already eased to 54.3 in July, down from 54.9 in the previous, signalling a weak start into the third quarter. Although, we remain confident the single currency is poised to appreciate against the greenback against the backdrop of stalling US rates and upcoming ECB tightening, the uncertainty generated by the trade conflict has skewed the game toward the USD, at least in the short-term.

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Will a rate hike suffice to stabilize the Turkish lira ?

June 24 presidential elections in Turkey gave Erdogan an unambiguous victory, confirming his second mandate as Turkish leader for another five years. However, in the view of investors, this puts into question the Central Bank of Turkey (CBT) independent status in managing Turkey’s monetary policy mandate since Erdogan recent declaration that he would have a greater say on monetary decisions.

Erdogan confirmed at multiple occasions his reluctance to higher interest rates, interpreted as a barrier to economic growth, a rather bad news for the lira, which already depreciated by 25.60% and 22.25% against USD and EUR since the beginning of the year.

Accordingly, the question raised is whether the new regime will have sufficient credibility in order to support the lira, or not. And today’s CBT monetary policy meeting decision will be decisive. Turkey’s inflation increased by 3% intra-month and is estimated above 15% while the current account balance continues to widen (USD -5.89 billion as of May 2018), partly due to a weaker lira, thus necessarily requiring higher interest rates.

The CBT already intervened on the marketplace in early June by raising its one-week repo rate by 125bps to 17.75% in order to support the currency. Accordingly, a move below 125 bps would be interpreted negatively by market participants, which would assume that the government maintains a certain control over the monetary authority, causing further TRY weakness.

Early trading session suggest further Turkish lira weakness, currently trading along 4.76, the USD/TRY is expected to decline further, the announcement will however have an impact on the intensity of the currency move. We expect the rate hike to remain at 100 bps, which will push the pair along 4.85 in the short-term.

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