Turkish Lira: Policy Normalisation Supports Carry Appeal, Says ING

ING has stated that the Turkish lira’s carry appeal is being supported by the ongoing policy normalisation, according to a recent note from the bank. This assessment comes as Turkey continues to shift toward more conventional monetary policies, a move that has bolstered investor confidence in the currency despite lingering inflation concerns.

Why Policy Normalisation Matters for the Lira

Policy normalisation refers to the central bank’s transition away from unconventional measures, such as heavy FX intervention and unorthodox rate cuts, toward a more standard inflation-targeting framework. Under the leadership of Governor Hafize Gaye Erkan, the Central Bank of the Republic of Turkey (CBRT) has raised its policy rate sharply since mid-2023, lifting it from 8.5% to 45% by early 2024. This aggressive tightening has restored some credibility to monetary policy and made lira-denominated assets more attractive to foreign investors.

The carry trade, which involves borrowing in a low-yielding currency and investing in a higher-yielding one, has become more profitable as Turkish real interest rates have turned positive. ING notes that the combination of high nominal rates and a relatively stable exchange rate has improved the risk-reward profile for holding lira, especially when compared to other emerging market currencies.

Current Market Context and Investor Sentiment

As of late February 2025, the lira has shown relative stability, trading around 34.5 per US dollar, after experiencing significant depreciation in previous years. The currency remains under pressure from high inflation, which stood at 38.2% annually in January, but the real rate is now positive, offering a cushion for carry trades. According to ING, the policy normalisation process is likely to continue, with the central bank expected to maintain a tight stance until inflation shows a sustained downward trend.

Foreign investor interest has been gradually returning, with portfolio inflows into Turkish bonds and equities increasing since the policy pivot. However, analysts caution that risks remain, including geopolitical tensions, external financing needs, and the potential for premature rate cuts. ING emphasizes that the carry appeal is conditional on continued policy discipline and a stable political environment.

Implications for Traders and Investors

For traders, the lira’s carry potential offers an opportunity to earn attractive yields, but it requires careful risk management. The high volatility and occasional sharp moves in the currency mean that positions should be sized appropriately and hedged where possible. Investors should also monitor the central bank’s communications and inflation data closely, as any deviation from the current policy path could quickly erode the lira’s appeal.

From a broader perspective, Turkey’s policy normalisation is a positive signal for emerging market investors, indicating a shift toward more orthodox economic management. If sustained, it could lead to a re-rating of Turkish assets and improve the country’s access to international capital markets.

Conclusion

ING’s view that policy normalisation supports the Turkish lira’s carry appeal reflects a broader confidence in Turkey’s monetary direction. While the currency remains vulnerable to external shocks and domestic challenges, the current policy framework provides a more favorable environment for carry trades. As always, investors should weigh the potential returns against the inherent risks of trading emerging market currencies.

FAQs

Q1: What is the carry trade in forex?
The carry trade is a strategy where investors borrow in a currency with a low interest rate and invest in a currency with a higher interest rate, earning the difference. In the case of the Turkish lira, investors borrow in currencies like the US dollar or euro and buy lira-denominated assets to capture the high yield.

Q2: How does policy normalisation affect the lira?
Policy normalisation, including interest rate hikes and reduced FX intervention, helps to restore confidence in the currency and attract foreign capital. This can stabilize the exchange rate and make lira assets more attractive, thereby supporting the carry trade.

Q3: What are the risks of trading the Turkish lira?
Key risks include high inflation, political uncertainty, geopolitical tensions, and the possibility of sudden policy shifts. These factors can lead to sharp depreciation, which may outweigh the interest rate advantage for carry traders.