Turkey should not change its economic policy

On global markets: Last Thursday and Friday were all about Turkish developments, which had a notable negative spillover effect on global markets too. After the lira fell by an eye-popping 11-12% vs. the US dollar in just one and a half days, President Erdogan suggested on Friday afternoon that an 'effective response to the West' would be to exchange dollars and gold held 'under the pillow' into Turkish liras, while he also stressed that the country 'will not surrender to economic hitmen'. After the words of Erdogan and US President Trump's tweet that he will increase tariffs further on Turkish steel and aluminum products, the currency took a further beating, meaning another roughly 9-10% decline in just a matter of hours. In the meantime, the ECB gave out a warning that some banks in the Euro Area might be exposed if Turkey's position worsens further, although also saying that the situation is not yet critical. As the premier seems to be sticking to the notion that Turkey should not change its economic policy, it is difficult to see what could stop the ongoing deterioration, although the extent of decline in the lira is very extreme and (in normal circumstances) would call for a correction.

CEE currencies: Currencies in the region were rather stable, or even appreciating, at the beginning of the week, with the exception of the Romanian leu, which gave up some of the gains from previous weeks after the NBR decided not to hike the policy rate. Later last week, however, the developments of the Turkish lira took their toll on CEE markets too. As CEE fundamentals are not comparable to those of Turkey, the market contagion effect was modest. If international sentiment, which is currently poisoned by the Turkish woes, worsens further, CEE currencies could also decline slightly. Fundamentally speaking, CEE currencies are not very mispriced at the moment. Thus, in the absence of any further deterioration in global sentiment, the Czech koruna should actually appreciate, while the Romanian leu should moderately decline. Still, at present, international factors seem more important for short-term FX moves.

CEE rates and yields: Rate developments in the Czech Republic and Romania were going in the opposite direction last week, as expectations for further hikes are still strong for the Czech case, while in Romania, the possibility of a no-change scenario increased after the NBR kept rates unchanged and the inflation print came in below expectations at 4.6% y/y for July. As for the latter, we think that there is now a lower chance that the NBR will hike than not this year. As for the Czech case, with core inflation admittedly being above the expectations of the central bank in July (the data was also released last week), we see the chances of the CNB delivering another rate hike at the next monetary meeting in late September as increasingly likely. Further rate developments are strongly dependent on the koruna as well. If the CZK fails to appreciate after another rate hike, then an additional hike by the end of the year will become increasingly likely as well. As for yields, Hungarian bonds were mostly sold last week, as evidenced by a near-20bp increase of the 10Y yield. 3X6 FRA and 2Y swap markets also started climbing higher recently. Although Hungary seems to be sticking to a rather loose monetary policy, the MNB said earlier that it does not see loose policy to be maintained at current levels in the relevant 5-8 quarter horizon, while Hungary's current and capital account position is also very strong and one of the best in the region.

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