NextFin News - Turkish riot police stormed the Ankara headquarters of the main opposition Republican People’s Party on Sunday, deploying tear gas and rubber bullets to evict party officials and supporters who had occupied the building for three days. This dramatic escalation of domestic political turmoil, coming on top of severe economic strains from the war in Iran, has shattered investor confidence and sent Turkish financial markets into a tailspin.
The political crisis erupted after an appeals court nullified the election of Ozgur Ozel as chairman of the Republican People’s Party, known as the CHP, and ordered that his predecessor, Kemal Kilicdaroglu, be reinstated. The CHP, which has been running neck-and-neck with President Recep Tayyip Erdogan’s ruling party in recent polls, condemned the ruling as a judicial coup. The ensuing standoff triggered a massive market sell-off on Thursday, May 21, with the benchmark BIST 100 index plunging 6% and halting trade, while bank stocks plummeted nearly 9%, before staging a partial recovery on Friday.
In response to the political crisis and the persistent energy shock, traders are aggressively ramping up bets that the Central Bank of the Republic of Turkey will be forced to raise interest rates. According to Bloomberg, overnight indexed lira swaps jumped approximately 105 basis points on Friday to imply a funding rate of roughly 41.75%, signaling that the market expects a rate hike at the upcoming Monetary Policy Committee meeting on June 11. This is a sharp reversal from April, when the central bank held its benchmark one-week repo rate steady at 37.0%.
This domestic political shock collides with a fragile macroeconomic backdrop dominated by the war in Iran, which began in late February 2026. The conflict has driven up global energy prices, complicating Turkey's inflation outlook. Just two weeks ago, on May 14, Central Bank Governor Fatih Karahan announced that the central bank was lifting its year-end inflation target to 24% from 16%, citing the massive uncertainty precipitated by the war.
The double whammy of political instability and energy-driven inflation is threatening to dismantle the lucrative Turkish lira carry trade, which had been one of the most popular emerging-market strategies for nearly three years. According to Bloomberg, major investment banks including Bank of America Corp. and Barclays Plc have recently abandoned their bullish positions on the lira. This represents a significant shift in sentiment, as foreign capital had previously poured into Turkish assets following Finance Minister Mehmet Simsek's return to orthodox economic policies in mid-2023.
To defend the currency and manage liquidity, the central bank has engaged in aggressive interventions. Metals Focus estimates that the central bank sold 52 tonnes of gold between late February and late March, dragging its net holdings to a two-year low of 440 tonnes, while also burning through over $26 billion in foreign exchange reserves.
However, a rate hike is not a foregone conclusion, and some market participants urge caution. While swap markets are pricing in a June hike, some economists argue that the central bank may resist a blunt rate increase to avoid choking off economic growth. Karahan has emphasized that the bank is actively using macroprudential liquidity and reserve management tools to manage the pressure. In a financial stability report published on Friday, the central bank maintained that the pressures stemming from the Middle East conflict are being successfully managed through these proactive liquidity measures. Furthermore, any potential de-escalation or ceasefire in the Iran conflict—such as the brief truce seen in April—could quickly cool global energy prices and relieve the pressure on the lira, rendering aggressive rate hikes unnecessary.
The fiscal cost of the energy shock is also mounting. Energy Minister Alparslan Bayraktar recently disclosed that state energy company BOTAŞ's subsidies, which cover the gap between global and domestic gas prices, are projected to triple this year to approximately 950 billion lira from an initial estimate of 300 billion lira. This fiscal deterioration, combined with the judicial assault on the political opposition, leaves foreign investors with little appetite for Turkish risk.
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