Foreign exchange rates pose the biggest threat for inflation

July inflation was generally in line with market expectations; thus annual inflation rates continued dropping. Annual inflation as of the end of July is at its lowest level for the past 26 months, even lower than May 2013, becoming 6.81 percent. 

Despite this, market experts are not hopeful on inflation. They especially regard the increasing foreign exchange prices as the biggest threat to inflation. The dominant expectation is that annual inflation will soar starting in September, with the base effect disappearing.  

In its inflation report last week, the Central Bank increased its estimates with a very small margin and raised its annual target from 6.8 percent to 6.9 percent. On the other hand, even according to optimistic estimates in the markets, inflation at the end of the year is expected to be 7.5 percent or higher.  

Last year in August, the increase in the consumer price index (CPI) was 0.09 percent, in September 0.14 percent, in October 1.90 percent and in November it was 0.18 percent. In December, there was a decline of 0.44 percent. End-of-year inflation was 8.17 percent. 

At the end of this year, an annual inflation rate of over 8 percent is not expected. Generally, the opinion that it will stay between 7.5 percent and 8 percent is dominant. However, if there are very rapid movements in foreign exchange rates after this, then last year’s end-of-year inflation figure can again be reached. 

Both the Central Bank and market players expected the July inflation figures to be low and a decline in the annual inflation rate. For this reason, the figures disclosed at the beginning of the week were not a surprise. 

Central Bank Gov. Erdem Başçı, while reading the inflation report last week, said they expected the inflation to go down below 7 percent by the end of July, but for this to continue from now on, a collective effort is needed. 

Terror and political uncertainty increase  

Başçı, while talking positively due to the decline in food inflation, also mentioned the negative effect of foreign exchange rates on inflation. I think it would be good not to be hopeful so early on food inflation either. 

Also, there is the risk of the effect of the exchange rates exceeding the Central Bank’s estimates. As in all developing countries, because of global reasons, here also, an increase in foreign exchange rates associated with foreign capital exit is expected. However, we see that the Central Bank has not quite included the risks associated with terror and the political dispute atmosphere. 

It looks as if the probability of a coalition government not being formed, but rather the holding of new elections soon, has increased. This case would mean a further increase in the reluctance of foreigners. All of them point to an acceleration of the already expected hike in the foreign exchange rates, which in turn will increase inflation.