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Turkish lira leads emerging market currency advances in July

The Turkish lira was the best-performing emerging market currency in July having strengthened against the dollar even as the Türkiye Cumhuriyet Merkez Bankası AS (CBRT) cut interest rates, while central and eastern European currencies were among the weakest performers.

Turkey's currency remains the third-worst emerging market currency tracked by S&P Global Market Intelligence so far in 2019, down 5.1%, but it enjoyed a bumper month in July, bouncing 4.4% against the dollar even as the Turkish central bank began to scale back interest rates.

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In a widely anticipated move the CBRT cut rates by 425 basis points to 19.75%, while it revised down its end-2019 inflation forecast to 13.9% from 14.6%, having already seen inflation fall from a peak of 25.6% in October 2018. Governor Murat Uysal implied further reductions in rates could be on the cards, "there could be significant room for manoeuvre in monetary policy."

"For at least some investors who are looking for high yields across emerging markets, Turkish rates are still at sufficiently attractive levels even after such a substantial rate cut," said Piotr Matys, an FX strategist at Rabobank in an email.

"The risk that the CBRT could cut rates too deep is relatively high," Matys said, noting sentiment in emerging markets can be fickle. "The lira is mainly driven by speculative inflows these tend to be short-term in nature and can be quickly reversed."

The Brazilian real was among the other major emerging market currencies to end the month up against the dollar, gaining 1.8%. Investors reacted warmly to President Jair Bolsonaro's pension reforms, which passed through the lower house of the Congress on July 11 with a sizable majority. However, the real has lost some ground recently as investors anticipate monetary easing from Brazil where the central bank is expected to cut rates by 25 basis points to 6.25%.

The Israeli shekel (+2.1%), Mexican peso (+1.2%) and Indonesian rupiah (+0.7%) recorded the other largest gains against the dollar.

The Argentine peso was again the worst performer, shedding 3.5% in the month. It is now down 13.5% from the start of the year, well clear of the South Korean won (-5.7%) in second place as the worst performer in 2019. Central and eastern European currencies performed poorly as a block, with the Hungarian forint, Polish zloty and Czech koruna all falling 3.1%.

The Hungarian forint has been under pressure, dropping 3.1% against the dollar as the central bank committed to a dovish stance in the face of inflationary pressures. But at 3.4% in June, inflation was the lowest it had been since February and was well within the central bank of Hungary's Magyar Nemzeti Bank 2%-4% range.

"We think the worst for Hungarian forint is over," Péter Virovácz, senior economist at ING, wrote in a research note. "Normalisation in Hungarian headline CPI lower should ease concerns about NBH credibility [and] the attractiveness of Hungarian government bonds should also positively spill over into FX."