UPDATE 3-Turkish lira strain shows as London overnight swap rates soar

(Adds falls in share index, dollar bonds)

By Ali Kucukgocmen, Nevzat Devranoglu and Jonathan Spicer

ISTANBUL, Aug 4 (Reuters) – Interest rates on overnight swaps for Turkey’s lira hit 1,050% Tuesday, the highest in more than a year, in an offshore market that Turkish authorities have starved of liquidity as part of a costly effort to boost the currency.

The rate in the London market was the highest since March 2019, Refinitiv data showed, reflecting what traders and analysts said was a cash crunch and pressure from Ankara.

The offshore market rate, once widely used for hedging and shorting by overseas investors, stood at 30% late last week when the lira touched a record low spot price against the euro.

One banker said the market for cash in London was “uber tight” after a four-day Turkish holiday weekend, while another said that “rates surge whenever there is some demand” after a such a long period of low volumes.

During another lira sell-off in March and April last year – when the overnight swap rate hit 1,200% – Turkish authorities directed banks to curb trading in the London market.

After an unusually stable two months due in part to costly state interventions, the lira was hit last week by selling and volatility, reflecting concerns over depleted FX reserves and Turks buying hard currency.

The offshore market had remained largely dormant until Tuesday when rates spiked, while the underlying lira slipped only 0.4% against the dollar.

Turkey’s central bank and state banks have spent tens of billions of dollars to stabilize the lira, data and calculations made by traders show. If it cannot rebuild reserves soon, Ankara risks a swollen current account deficit, more lira depreciation, and higher inflation via imports, analysts say.

Central bank governor Murat Uysal repeated last week that reserves naturally fluctuate during times of market stress such as a pandemic.

The lira touched a record low against the dollar in May and had hovered around 6.85 for two months before weakening briefly beyond 7.0 last week. It was trading at 6.971 at 1247 GMT on Tuesday.

“A break above 7 is probably only a matter of time unless the outlook for the Turkish economy improves significantly over the next few months,” said Piotr Matys, senior strategist at Rabobank.

Turkish authorities appeared to be trying to discourage bearish bets by making the London market as expensive as possible, he said, adding: “It is a confirmation of how vulnerable the lira is that they have to re-use such drastic tools.”

Turkey’s main share index BIST100 fell more than 5% during the day and was down 3.53% at Tuesday’s close. Turkey’s dollar bonds also fell 1.9 cents.

Jason Tuvey, senior emerging markets strategist at Capital Economics, said the fall in the index was due to investors selling assets to access lira liquidity as well as concerns over policymaking in Turkey.

(For a graphic of the swaps rate vs spot price, click: tmsnrt.rs/3kciWKn)

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