While large fluctuations among emerging market currencies are nothing new, the scale of the Turkish currency’s latest slide is of a magnitude rarely seen in recent years. But what is behind the Lira’s sharp sell-off and what impact is this dramatic move having on global currency markets?

1) Worsening relations with the US

A worsening in relations between Turkey and the US, one of the country’s largest trading partners, is one of the primary drivers behind the hammering of the Lira so far in 2018. The detention of American pastor Andrew Brunson, accused of playing a part in the failed coup attempt in Turkey in 2016, angered the Trump administration and contributed to the imposition of sanctions from the US President on the country’s justice and interior ministers earlier this month.

To make matters worse, Trump announced he was greenlighting a doubling of tariffs on imports of steel and aluminium out of Turkey. President Erdogan and his financial advisers appear to be losing control of the situation and his increasingly bizarre and unhelpful statements have far from calmed financial markets.

2) Deep economic problems

Turkey was also suffering from significant economic problems of late. While Turkey’s economy is one of the fastest growing economies in the world in recent years, much of this expansion was fuelled largely by foreign currency debt. This use of external debt led to the formation of a rather hefty current account deficit, which ballooned to 7.1% of overall GDP in first quarter of the year.

The Central Bank of Turkey (CBRT) currently has insufficient foreign exchange reserves to finance this deficit. Turkey’s FX reserves declined at an accelerated rate this year, due in part to the need to pay for imported oil in US Dollars, and are now below the level deemed sufficient by the IMF in order to weather a full-blown economic crisis.

3) A central bank failing to act

A lack of independence of the country’s central bank has significantly hindered Turkey’s efforts to rein in spiralling levels of inflation and protect the Lira. Under conventional circumstances, sky-high inflation and a freefalling currency would encourage the country’s central bank to aggressively raise interest rates. The central bank has, however, long been at odds with President Erdogan, a self- described ‘enemy of interest rates’, who persistently called for lower rates in Turkey to fuel credit growth and economic expansion.

Instead, the CBRT was largely forced to use a number of more unorthodox tools in an attempt to prop up the currency, although these measures have, so far, had little effect. There is a complete lack of confidence among the market that authorities in Turkey have either the willingness or ability to raise interest rates in order to stem the currency’s latest slide.

We expect the market to continue to pay close attention to developments in Turkey in the coming days. A further aggressive sell-off in TRY would no doubt keep downward pressure on the Euro and Sterling, both of which could prove susceptible to further modest losses this week.