Concerns about the direction of Turkish foreign policy are well founded while the Erdogan regime takes increasingly provocative actions. Controversy clings to the Turkish President for good reason; he recently fired his central banker and promised to cut interest rates in the heterodox belief that higher interest rates stoke inflation. His newly appointed central bank replacement, Murat Uysal, has since expressed a more nuanced view, undoubtedly seeking a middle ground palatable to both financial markets and his eccentric employer. Rather than targeting inflation outright, Mr Uysal has said the bank will target real rates—inflation-adjusted interest rates—to reduce real borrowing costs. The credibility of monetary policy is a key determinant of price stability; if markets perceive an unstable policy path, they request a higher return for this risk. The central bank must increase policy rates to combat flighty investors and the resulting currency devaluation. Given a 5.0% decline in inflation this year, there is undoubtedly room to decrease rates, but as is true with every central bank, nuanced communication is key. The challenge will be adopting a credible policy suitably varnished for both internal and external consumption. Recep Erdogan’s title, the enemy of interest rates, make that balancing act a tough job indeed.
Bottom line: The monetary policy question is only one of our concerns surrounding Turkey. Continued oil drilling on Cypriot territory has escalated a dispute with the EU, which is pulling government contracts in response. Erdogan has also purchased the S-400 missile system from Russian, raising US ire, and intends to begin joint production as well.
It may be surprising, but the EU does seem to be taking the renewed threat of a no-deal seriously, but negotiations appear to be souring behind the scenes. According to official sources, the EU is weighing new concessions for Britain’s next Prime Minister, raising hopes that this might conclude the issue at last. Unfortunately, at a meeting last week between Brexit Secretary, Stephen Barclay, and the EU’s chief negotiator, Michel Barnier, the atmosphere was far from amicable. It’s been reported that the UK appeared to be trying to bully the bloc into concessions, making it one the most challenging encounters of the last three years and risks a hardening of the EU's position. The potential for a breakdown in talks is also higher because Boris Johnson’s role in the Leave campaign has irreparably undermined his credibility in the eyes of the EU contingent.
Before any progress can be made, the Irish backstop must be agreed. In a debate yesterday, both Johnson and Hunt noted that significant concessions to the backstop would be insufficient. This is likely a balm to the Democratic Unionist Party (DUP), which recently said that it wasn't looking for 'earth-shattering' changes to the backstop, but concessions will be necessary. The political turmoil over Brexit has resulted in the Pound depreciating to the bottom of its historic trade-weighted level. It is worth noting that in August, Sterling has weakened against the Dollar for the past five years and against the Euro for four, so there may be more pain to come.
Bottom line: New concessions could give the next Prime Minister a fighting chance of getting the current deal through Parliament, but both Johnson and Hunt seem adamant on dropping the Irish backstop from any agreement. This hard-line stance could sour relations further and potentially push the UK closer to a chaotic split.
Sterling is trading heavily in Tuesday’s European open as risks of a no-deal Brexit come to light again. The trade-weighted Dollar Index is climbing, pushing the pair back towards the 1.2450 support level that was hit last week.
The pair is moving towards year-to-date lows last seen in mid-January due to Brexit concerns flaring up again. While mostly Sterling driven, some Euro weakness is limiting the move lower.
The pair is ticking lower on Tuesday morning, mostly driven by Dollar strength. The trade-weighted Dollar Index is now back to its 100-daily moving average following its deviation lower last week.