Turkey’s central bank is expected to cut interest rates by 150 basis points in the upcoming Monetary Policy Committee meeting. This move is part of a trend towards easing, and markets are eager to see if this pace will continue. A lower-than-expected Consumer Price Index (CPI) for December, mainly due to non-food items, along with high reserves, supports the potential cut to 36.5%. However, there may be a smaller cut of 100 basis points due to rising food prices and signs that domestic demand is recovering.

Market Expectations

The market predicts an interest rate of 27% by the end of the year, while current rates are around 30.25%-30.50%. If the central bank gives clearer signals or if inflation unexpectedly drops, rates could rise more sharply. The Turkish lira remains strong and attractive for carry trade opportunities in emerging markets. Investor confidence is growing, evident in long positions in the lira, reaching an estimated USD 50 billion, surpassing last year’s figures. Last year’s 150 basis point rate cut marked the beginning of a significant easing cycle. At that time, we believed the policy rate would decrease notably, creating an attractive carry trade. This was bolstered by then-record foreign exchange reserves. By the end of 2025, the central bank was quite aggressive, lowering the policy rate to 25%, even below our initial forecast of 27%. Annual inflation fell from over 60% to just under 20% by December 2025. Although the lira depreciated against the dollar, the high yields compensated for the currency’s slow decline, making long positions in the TRY profitable for most of the year.

Trading Strategies

With the central bank currently pausing, the straightforward carry trade has become more crowded and uncertain. Traders should consider using derivative strategies, like selling out-of-the-money TRY puts, to earn premium while managing risk. This strategy leverages the expectation that authorities will prevent sharp currency drops, especially since foreign reserves remain strong at around $140 billion. The key focus will be the upcoming January inflation data. A higher-than-expected figure may lead the central bank to signal a longer pause, affecting crowded long-lira positions and causing short-term volatility. Forward contracts currently suggest a slower rate of depreciation for 2026, but this outlook hinges on inflation continuing to decline. Create your live VT Markets account and start trading now.

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