Weak Lira Threatens Turkey Disinflation Path

The pressure is building as Turkey’s foreign-exchange reserves fall. Central bank reserves dropped by nearly $8 billion to $149.2 billion in the week ended June 26, their lowest level in 13 months, according to the latest figures. That decline reduces the policy buffer available to smooth currency volatility at a time when investors are already watching whether authorities can maintain confidence while moving toward looser monetary policy.

Markets have been pricing in as much as 300 basis points of Turkish rate cuts this year, helped by softer oil prices and signs that price growth is no longer accelerating. But inflation remains elevated by global standards. Istanbul’s June inflation was 35.94% from a year earlier, with prices rising 1.14% on the month, underscoring that underlying price pressures are easing only gradually.

The dollar backdrop is also less forgiving. US 10-year Treasury yields rose to 4.48% on July 1, while two-year yields climbed to 4.17%, keeping demand for dollar assets firm. The Invesco DB US Dollar Index Bullish Fund closed at $28.34 on July 2, still above its 50-day and 200-day moving averages, a conventional technical sign of sustained dollar strength.

For Turkish assets, the tension is visible. The iShares MSCI Turkey ETF closed at $39.34 on July 2, below its 50-day moving average of $40.10 but above its 200-day average of $37.23, suggesting investors are not abandoning the market but are reluctant to price a clean disinflation trade while the currency weakens.

The central bank’s challenge is now credibility. Cutting rates too quickly could support growth and local equities, but it may also intensify pressure on the lira and revive inflation expectations. Holding policy tight for longer would protect price stability and reserves but risks slowing domestic demand.

The next inflation readings and reserve data will determine whether Turkey can turn steady inflation into durable disinflation, or whether dollar strength forces policymakers to delay the easing cycle investors have been counting on.