Debates on the latest inflation and interest rates

Turkey’s inflation rate for February was recorded higher than expectations. Consumer prices in February saw a change of 0.73 percent on a monthly basis as the year-on-year rate came to 10.26 percent.

The figures exceeded the widely expected estimate of 0.5 percent and has caused a negative view for the rest of the year among market players.

For a long time the Turkish government suggested that the inflation rate would drop to a single-digit figure by the end of February. Now ministers are saying inflation will drop to a single-digit figure by the end of April. Obviously they have been expecting a decrease caused by the base effect. Consumer price increase rates in three months of 2017, starting from March, were 1.02, 1.31 and 0.45 respectively.

This is why government circles calculate that the year-on-year change will be lower at the end of April.

Actually, markets players have been losing faith in expectations. Market analysts, interpreting the data for February, believe inflation rate are less likely to drop to the single-digit level in the following months due to three reasons: The disruption of price-setting behavior, high exchange rates and the buoyancy in domestic demand despite the recent decline.

Even if the single-digit inflation level target can be reached for one month, the annual inflation rate will be in double-digits inevitably, according to market analysts. In other words, almost all hopes in the markets to reach the single-digit inflation rate target have melted away.

On the other hand, producer prices have been floating on higher levels than consumer prices. The higher producer prices constitute the base of future increases in consumer prices as long as demand is strong. The domestic producer price index in February saw a change of 2.68 percent compared to the previous month. It surged 3.69 percent compared to December 2017 and 13.71 percent compared to February 2017. These figures hint at potential increases in consumer prices in the near future. The core inflation rate has hit 11.98 percent, also exceeding expectations.

The government pressure on the Central Bank

Expectations of an interest rate cut by the Turkish Central Bank prior to its Monetary Policy Committee meeting on March 7 was pretty low among the market players who have considered these hot figures.

The Central Bank did not lower interest rates on its March 7 meeting. But still some have been worrying about recent moves by the government to pressure the Central Bank to lower interest rates. President Recep Tayyip Erdoğan had again targeted last week the profits of the banks and had said that they will take a decision on interest rates following consultations with state banks and
presidential advisers.

What happens if pressure to cut the interest rates intensifies?

We may answer this question citing the opinions of some IMF analysts.

“[Inflation has increased] fueled by the large lira depreciation, in part due to higher demand, rising cost pressures, and rising inflation expectations… Without further interest rate increases, inflation is likely to end the year once again in double digits,” the IMF said in its Staff Concluding Statement of the 2018 Article IV Mission on Feb. 16.

“Such has been the strength of the recovery that the economy now faces signs of overheating: A positive output gap, inflation well above target, and a wider current account deficit. This increases Turkey’s potential exposure to changing global conditions,” it added.
In short, the Central Bank should increase interest rates instead of decreasing them, the IMF said, even before the February data
were released.