Turkey's lira set a new record low against the US dollar on Thursday as investors worried about the government's economic policies and dollar reserves appeared to be running low.

The lira was trading at 7.29 against the greenback around 1400 GMT, suffering a loss of more than 3.5 percent since the start of the day -- the lowest since May when it reached a then-record low of 7.24.

Since January 1, the Turkish currency has lost nearly 20 percent of its value against the dollar.

The lira also recorded its lowest level against the euro, trading 8.64 against the European currency at 1400 GMT, amounting to a nearly 3.5 percent depreciation.

The new fall comes as markets worry about a meltdown in the foreign currency reserves at Turkey's central bank, which appears to have spent lavishly in recent months to prop up the national currency.

The lira is at its weakest ever
The lira is at its weakest ever AFP / Yasin AKGUL

State banks were also pushed to sell dollars to help the weakening lira.

An economic slowdown due to the novel coronavirus pandemic hit Turkey hard just as it was trying to recover from its first recession in a decade.

The pandemic has particularly dented the country's tourism industry, the backbone of the economy.

In a statement after the dramatic lira losses the central bank defended its record, saying its fiscal and monetary policies "succeeded in containing the effects of the pandemic" on the economy.

The bank said recent data suggested that an economic recovery had gained pace and that with economic activity normalising as of early August the targeted additional liquidity facilities would be phased out.

But it would keep a close eye on the movements of prices.

There's no end in sight for the lira's troubles, some say
There's no end in sight for the lira's troubles, some say AFP / Yasin AKGUL

"The central bank will use all available instruments to reduce the excessive volatility in the markets in line with the price stability and financial stability objectives."

Jason Tuvey, senior emerging markets economist at London-based Capital Economics, predicted that the central bank's efforts to stem the lira's decline "will ultimately prove futile and that the lira has further to fall".

Turkey's rising tensions with the European Union were the "main driver of downward pressure on the lira," he wrote in a note to clients.

Ankara's actions in the eastern Mediterranean, where it has clashed with EU members Cyprus and Greece, as well as the migrant crisis have strained ties with Brussels.

"We expect the currency to weaken to 7.50/$ but, if tensions with the EU and/or broader concerns about the policymaking environment in Turkey escalate, the risk of much larger and sharper declines would grow," Tuvey said.

Turkey's central bank -- which is nominally independent but often the target of government pressure -- has lowered interest rates to 8.25 percent from 24 percent since July last year, to the dismay of many foreign investors.

President Recep Tayyip Erdogan has repeatedly called for lower interest rates to promote growth at the expense of reining in inflation.

He once called high rates the "mother and father of all evil."

July's annual inflation rate was 11.76 percent, down from 12.62 percent in June, according to official data, but still well above the government's own year-end inflation target of 8.5 percent.

The Turkish economy was struck by a currency crisis in 2018 over escalating tensions with its NATO ally the United States, which sparked emergency rate hikes by the central bank.