Turkey’s lira weakened 0.8% to a record low on Thursday, extending losses after a heavy selloff in the previous session that was seen as a sign of the authorities easing controls on the foreign exchange market. 

The currency later recouped some of its losses, standing at 23.33 against the dollar by 0542 GMT, after touching a record low of 23.39 overnight during illiquid trading hours. 

On Wednesday, the lira had plunged 7.2%, recording the biggest intraday drop since a historic crash in late 2021, after the central bank slashed rates in the face of rising inflation as part of President Tayyip Erdogan’s unorthodox policies.

Economists said the lira’s sharp drop was a signal that Ankara was moving away from state controls towards a freely traded currency, albeit there are numerous regulations and measures that are yet to be rolled back.

The currency is nearing levels where it does not need to be defended through the use of reserves, traders said, adding that they do not expect the lira to depreciate on Thursday as much as it did a day earlier.

“There is no air of panic in the markets as in previous times when there were such high losses. On the contrary, there is a perspective of normalization, which is important,” a forex trader said.

Under Erdogan’s unorthodox programme, authorities have been taking a hands-on role in foreign exchange markets, using up tens of billions of dollars of reserves this year alone to hold the lira steady. 

But following his re-election last month, Erdogan signaled a U-turn at the weekend by naming Mehmet Simsek, a former deputy prime minister well regarded by foreign investors, as Turkey’s new finance minister.

Simsek later said economic policy needed to return to “rational” ground and on Wednesday said there were “no quick fixes” for policy.

CHANGE OF TACK

“We see the lira correction as a realization on behalf of Turkish policymakers that its liberal use of reserves to defend the currency has run its course for now,” said Erik Meyersson, chief emerging markets strategist at SEB.

He said the lira could reach 27 against the dollar by the end of the year. “This is a downward revision to the value of the lira that reflects expectations of authorities trying to control the lira somewhat less,” Meyersson wrote.

The central bank’s net forex reserves hit an all-time low of negative $4.4 billion last month as demand surged through the elections.

The decline in the reserves was expected to have stopped last week, with traders saying they could enter an upward trend. However they also highlighted the threat posed to the reserves from payments due to be made under a government scheme that protects lira deposits against forex depreciation.

Investors are now awaiting the appointment of a new central bank governor to succeed Sahap Kavcioglu, who has spearheaded Erdogan’s rate-slashing drive since 2021.

Under pressure from Erdogan, a self-described “enemy” of interest rates, the central bank cut its policy rate from 2021, sparking a historic lira crisis that sent inflation to a 24-year high above 85% last year.

Erdogan is considering appointing Hafize Gaye Erkan, a U.S.-based senior finance executive, as central bank governor, Reuters reported on Monday. 

Some economists expect an emergency rate hike – to around 25% from the current 8.5% – ahead of the central bank’s next scheduled meeting on June 22.

The dollar fell slightly on Thursday from near three-month highs, a day after a surprise rate hike from the Bank of Canada suggested the Federal Reserve may also have more work to do to combat inflation.

The euro was last up 0.3% at $1.073 against the dollar – the most traded currency pair in global markets.

That was despite data showing that the euro zone economy slipped into a mild recession in the first quarter, after gross domestic product statistics were revised.

The dollar index, which measures the currency against six major peers, was down 0.19% to 103.84. Last week the index hit 104.7, the highest since March 15.

A view among investors that the U.S. 2-year bond yield had potentially peaked was weighing on the dollar, said Simon Harvey, head of FX analysis at Monex Europe.

But, he added: “We must highlight that the moves we’re seeing today are marginal.”

Yields on the U.S. 2-year Treasury rose after the Bank of Canada decision and hit 4.592% on Thursday before slipping back to 4.565%. Bond yields are key drivers of currencies, with higher rates typically attracting investment.

The Bank of Canada surprised traders by raising interest rates to 4.75%, a 22-year high. It followed a rate hike by the Reserve Bank of Australia on Tuesday.

“The view here was that if both Australia and Canada felt the need for further hikes, in all probability the Fed would too,” Chris Turner, head of markets at ING, said in a note to clients.

Against Canada’s dollar, the U.S. dollar was down 0.19% at C$1.335, after falling 0.24% on Wednesday.

The Australian dollar was up 0.43% at $0.668, taking its monthly gains to roughly 2.7%. Sterling was 0.21% higher at $1.247.

The Canadian decision put the spotlight back on the Federal Reserve, which sets interest rates on Wednesday next week.

According to derivative market pricing, traders currently think there’s a 70% chance the Fed will hold rates steady next week, and a 30% chance of a 25 basis point (bp) increase. 

They think the Fed could then raise rates by 25 bps in July, after policymakers hinted at a so-called skip. That would boost the Fed funds rate to a range of 5.25% to 5%.

The European Central Bank sets rates on Thursday and traders broadly expect a 25 bp hike, to be followed by another 25 bp increase in July, taking rates to 3.75%.

In Asia, the dollar was down 0.29% against Japan’s yen at 139.71 yen per dollar, after rising 0.37% the previous day.

The onshore and offshore yuan eased to their weakest in six months against the dollar, further pressured by economic worries.

Data released on Wednesday showed China’s exports shrank much faster than expected in May while imports extended declines, raising doubts about the country’s fragile economic recovery.

Meanwhile, the Turkish lira slipped to a record low of 23.39 per dollar in early Asia trading. It remained under pressure, last at 23.36.

The yen will likely continue to drag its heels against the dollar, MUFG says, as the latest economic Japanese data showing weaker wage growth is expected to keep the Bank of Japan leaning dovish at the policy meeting next week.

USD/JPY was up 0.1% to 139.66.

Without a shift in BoJ policy to a less dovish stance, the yen is “more likely to continue trading at weak levels,” MUFG said following weaker-than-expected wage data overnight Tuesday.

Real wages in Japan dropped 3.0% from a year earlier in April, the labor ministry reported Tuesday, steeper than the 2.0% economists had expected and will “reinforce market expectations for the BoJ to maintain current loose policy settings at this month’s policy meeting on 16th June and for the rest of this year,” MUFG added.

The weakness in April was driven by a “drop in overtime earnings, which fell for the first time in more than two years, and subdued bonus payments growth,” Daiwa Capital Markets said in a note.

The yen’s breach of 140 against the greenback on Monday stoked talk that the central bank could intervene to prop up the currency following a similar move last year when the yen topped 150 against the dollar.

But the latest data is a setback for the BoJ, MUFG says, as the central bank was expecting that the recent round of agreements by labor unions and employers to hike wages would have been reflected in the data.

“The BoJ has been expecting around 40% of the wage negotiation results to have been reflected in April with the number rising to more than 80% by July,” according to MUFG.