There are risks tied to ongoing rate cuts by the Turkish central bank amid renewed inflation expectations. Household inflation expectations increased, with a 12-month forward expectation hitting 54.4% in October, driven by administrative price hikes and persistent food price rises. Households remain sceptical about inflation decreasing towards target levels.

Political Uncertainty in Turkey

Political uncertainty is noted as the Nationalist Movement Party’s surprising boycott of a Presidential reception points to coalition tension. Differences between President Erdogan and MHP leader Bahceli on the peace process and Cyprus elections raise concerns on internal cohesion. The net open foreign exchange position of non-financial companies widened by 1.6% to $184.9 billion by the end of August, reflecting faster expansion in liabilities.

Despite claims by policymakers, Turkey’s net foreign exchange reserves stand at $12 billion and have been decreasing. Claims of high reserves often cite a gross international measure including gold, reflecting merely an increase in gold valuation. The fundamentals for the lira exchange rate are not improving, with political fragility and market volatility complicating the central bank’s efforts. The premature easing step by the central bank against rising inflation risks reduces the attraction of Turkish lira deposits, potentially increasing foreign exchange demand.

As we see it, the fundamental risks for the Turkish lira are re-emerging, echoing challenges we have observed in the past. Household inflation expectations are again a major concern, with the latest survey data from this month showing 12-month forward expectations have ticked up to 59.8%. This follows the release of September 2025’s official CPI figure, which came in at a worrying 68.5% year-over-year, suggesting a deep-seated lack of confidence in price stability.

Central Bank Credibility Issues

The central bank’s actions last week are not helping to build credibility or support the lira. By delivering a smaller-than-expected interest rate hike of only 100 basis points, the CBT has reduced the relative appeal of holding lira deposits, especially when real returns remain deeply negative. This decision feels similar to past premature easing cycles that ultimately fueled more demand for foreign currency.

For derivative traders, this environment signals a strong likelihood of increased volatility in the coming weeks. The clear disconnect between persistent high inflation and a hesitant monetary policy response creates an ideal setup for long volatility strategies. We believe buying USD/TRY call options or TRY put options offers a favorable risk-reward profile to capitalize on potential sharp downward moves in the lira.

Underlying fundamentals also justify a bearish outlook, as they have not materially improved. The latest CBT data from mid-October 2025 shows net international reserves, a key measure of the bank’s ability to defend the currency, have fallen to just $9.5 billion. This leaves the lira extremely vulnerable to shifts in sentiment, as the central bank has limited firepower for any meaningful intervention.

Political fragility is once again adding to market uncertainty, much like the coalition strains we saw years ago. Current public disagreements between coalition partners over the 2026 budget are raising concerns about policy coordination and fiscal discipline. Any escalation in these tensions could serve as a direct catalyst for another wave of lira depreciation.

Therefore, positioning for further lira weakness appears to be the most prudent strategy. Traders should consider using derivative instruments to short the lira, as the combination of high inflation, an unconvincing policy response, and low reserves points to a continued depreciating trend for the currency. The path of least resistance for USD/TRY remains upward.

Create your live VT Markets account and start trading now.