Iran military action boosts inflation + political crisis suppresses lira, Turkey's interest rate hike expectations rise in June.

Investors are increasing bets that the Turkish central bank will raise interest rates as rising energy costs keep inflation elevated and political crises put pressure on the lira. The swap market currently expects the Turkish Monetary Policy Committee to raise rates at its meeting on June 11th, with overnight index swap rates jumping around 105 basis points last Friday, implying a funding rate of about 41.75%. In comparison, the Turkish central bank's one-week repo rate is 37%, while the actual average funding cost is 40%. Alp Serbetli, Chief Financial Officer of Industrial and Commercial Bank of Turkey Investment, said, "The swap market is once again factoring in rate hikes, and current pricing suggests that there might not be any rate cuts for the remainder of the year." This shift is also accompanied by global banks changing their forecasts. JPMorgan currently expects the policy rate to increase from 37% to 40% in June, citing the dismissal of the main opposition party leader by the court, which has increased market uncertainty. HSBC also stated that if dollarization pressure or foreign outflows accelerate after this ruling, the Turkish central bank may adopt a tighter policy. The swap market is betting on a rate hike by the Turkish central bank. Last Thursday, a Turkish court declared the 2023 congress election results of the Republican People's Party (CHP) invalid, reinstating the party's previous leadership and declaring all decisions made since the election null. This ruling has sparked protests and shaken the Turkish market. The Turkish stock market fell after the ruling was announced, with state-owned banks stepping in to support the lira, leading to the sale of billions of dollars in the market. The stock market later rebounded, but bond yields continued to rise in local currency terms. Bloomberg economist Selva Bahar Baziki said, "After the court's decision to dismiss the main opposition party's leadership on May 21, the Turkish lira exchange rate declined, depleting foreign exchange reserves and forcing policies to become even tighter. We have withdrawn our expectations of rate cuts this year. Additionally, we expect the future financial environment to become even tighter, with actual lending rates possibly rising by 300 basis points." This political turmoil comes at a time when policymakers are grappling with a new round of inflation pressure from rising energy prices following the outbreak of the Iran war. Earlier this month, the Turkish central bank raised its year-end inflation target from 16% to 24% due to surging energy prices. The country's annual inflation rate in April was 32.4%. Earlier on Saturday, the Turkish central bank further tightened financial policy by reducing the limit on some loans. Since the outbreak of the war, the Turkish central bank has avoided direct interest rate hikes. However, by directing funds to the higher-cost overnight lending rate (40%) instead of the one-week repo rate (37%), they have effectively tightened policy. However, not all economists expect the Turkish central bank to raise rates soon. Goldman Sachs stated that a rate hike is unlikely in the short term, predicting rates to remain unchanged in June and thereafter unless continued dollarization forces a policy change. It is reported that the Turkish lira has long faced depreciation pressure, with the lira falling 6% against the dollar since the beginning of the year.