A currency exchange office in Istanbul. © Getty

Turkish financial markets were hit with severe ructions on Friday morning as the lira plunged more than 10 per cent against the dollar, before recovering to some extent.

Later in the day, Berat Albayrak, the finance minister, is due to unveil “a new economic model” outlining steps to reduce debt, the budget deficit and the large current-account gap.

Here’s what analysts had to say:

“Today’s sharp fall reflects complete lack of confidence in the lira. The central bank must raise interest rates substantially to stabilise the currency. The precipitous fall in the value of the lira will have serious inflationary consequences and even more importantly may lead to a financial crisis and recession,” said Piotr Matys, analyst at Rabobank. A “substantial hike is urgently required of at least 10 percentage points,” he added.

Jane Foley, also at Rabobank, said Mr Erdogan’s “defiant” comments last night “had reduced the markets hope” that the Turkish government is willing to tighten monetary policy or begin economic reform.

“Right now this morning, the market is not getting the signals that the finance minister is going to come through with what the market wants,” she added.

Gyorgy Kovacs, analyst at UBS, said the lira’s fall in August “has much to do with rapid public escalation of tensions between the US and Turkey” and resulting US sanctions. “A combination of easing of tensions with the US” and a rate hike of 3.5 - 4 percentage points “would offer the best support for the Turkish currency,” he said.

On what is now needed, Charles Robertson, chief economist for EM-focused Renaissance Capital, said: “Rate hikes on their own are not enough . . . The government needs to demonstrate the [central bank] can act.”

Analysts at JPMorgan said rate hikes alone “will likely not be sufficient and possibly counter-productive.” They said a “comprehensive package” was required, which should include rate hikes of between 5 - 10 percentage points, a fiscal package to backstop and recapitalise banks, targeted fiscal support for the most distressed sectors and a policy framework that recognises the “need for deleveraging and recognises a recession is a natural side product of this process.”

Despite the Turkish lira “flash crisis” and resulting sell-off, the spillover into the euro “was limited (non-existent) — implying that the euro contagion effects may be more acute and muted than initially feared,” said Viraj Patel, foreign exchange strategist at ING. “This may hold for the time being unless the implications for the European banking sector deteriorates materially,” he said.

Meanwhile, analysts at Commerzbank said Mr Albayrak’s expected downward revision of the economic growth forecast from 5.5 per cent to between 3-4 per cent was “optimistic” but was at least “in the right direction” — unlike “the situation with inflation.”

“The ministry of finance is already talking about single-digit rates again which are going to be reached ‘as soon as possible’. In real life it looks as if things will move into a completely different direction,” they said. “There is a risk that the minister of finance will provide a completely unrealistic view of the situation,” which could cause the market to become “even more concerned.”

Derek Halpenny, European head of global markets research at MUFG, also raised concerns about the credibility of the finance ministry: “Today, we are set to hear details on a ‘new economic model’. The problem is that President Erdogan replaced his credible and respected Finance and Treasury Minister with his brother-in-law, Berat Albayrak. Hence, market optimism of what this ‘new economic model’ will bring is low,” he said.

“With President Erdogan resisting aggressive monetary tightening, some form of capital controls could be the initial step taken, although how those controls would be designed would be difficult given the need not to disrupt foreign currency debt financing,” he added.

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