The Turkish lira (TRY) on March 8 more or less shrugged off the surprise ratings downgrade for Turkey announced the previous day by Moody’s Investors Service, but the 10-year government Turkish note fell for a second day and its was yield pushed out to the highest level seen in almost three months.

While the Turkish lira was trading at 3.8127 against the US dollar, a loss of 0.50% d/d, as of 14:00 local time, and the benchmark BIST-100 Istanbul stock market index was up 0.18% to 117,051, the annual yield on 10-year benchmark government bonds rose by 12bps to 12.32%.

ING’s Istanbul-based head of trading Murat Yardimci was quoted by Bloomberg as saying Moody’s decision would have a “first-day” impact on the market, which would then start trading in line with other emerging markets. Yardimci expected the USD/TRY rate to hold in the 3.7950-3.8250 range, and 10-year bond yields to hold around these levels before the treasury’s debt auctions next week.

The downgrade to two notches below investment grade puts Turkey on par with Brazil, Croatia and Costa Rica.

It was late on March 7 when Turkey’s credit rating was cut further into junk by Moody’s with the ratings agency citing an erosion of institutional strength and added risk of external shocks. Moody’s lowered the rating on the Turkish government’s long-term issuer and senior unsecured debt ratings to two levels below investment grade, taking it to ‘Ba2’ from ‘Ba1’. Kristin Lindow, a Moody’s analyst, said the Turkish government seemed focused on short-term measures, undermining effective monetary policy and economic reform. That’s become a concern to an increasing number of analysts in recent months, who ask how much longer Turkey can maintain economic stability in these circumstances. 

Turkey’s central bank on March 7 kept its main interest rates unchanged despite its need to fight stubborn double-digit inflation and core inflation that remains elevated. 

William Jackson, senior emerging markets economist at Capital Economics, said in response to the central bank’s rate decision that the monetary policy committee (MPC) was expected to keep its rates at current high levels over the course of this year, even as inflation subsides.

Turkey’s annual consumer price inflation came in at 10.26% for February, the lowest level recorded since July last year but a disappointment to analysts who hoped for something more impressive.

S&P Global Ratings could downgrade Turkey if monetary policy proves inadequate to curb double-digit inflation and currency pressures, the rating agency said on February 23 when it affirmed its unsolicited 'BB/B' foreign currency long- and short-term sovereign credit ratings and its unsolicited  'BB+/B' local currency long- and short-term sovereign credit ratings on Turkey with negative outlook.

S&P also said the picture could worsen due to Turkey's reliance on volatile portfolio inflows to finance its sizable current account deficit. “Additional currency weakness could, in our view, lead to a deterioration of asset quality in the financial sector, given the substantial share of foreign currency claims on residents by Turkish banks,” the rating agency added.

Moody’s expects the inflation rate will rise to 12.2% at end-2018 from 11.9% at end-2017.

Fitch Ratings rates Turkey at 'BB+'/Stable.