Interest rate reduction expected despite inflation

This week, on one hand, markets will be monitoring the statements of authorities who affect global economy, and on the other hand, domestically, they will closely follow the Central Bank’s interest rate decision. The expectation in the markets is that despite all the negative circumstances, the Central Bank will continue lowering the interest rate. 

In the Monetary Policy Board (PPK) meeting to be held later this week, banking executives expect the Central Bank to decide on an interest rate decrease of 0.50 base points. Even though the June inflation rate that was released at the beginning of this month came out to be higher than the Central Bank’s expectations, again, a reduction decision is expected. 

As a matter of fact, when these high rates were released, for a few days, it was believed the Central Bank would not lower the interest rates any further. However, after those few days, the markets started to expect a decrease again.

The biggest reason for this change in expectation was the continued pressure, in the meantime, from Prime Minister Recep Tayyip Erdoğan, who is running for office in the presidential race, on the Central Bank to lower interest rates. PM Erdoğan has not once given up on pressuring the Central Bank, even in his presidential campaign rallies. Seeing this insistence, the markets started thinking the Central Bank would not be able to ignore the prime minister’s pressure.

In other words, despite the prime minister and his aides, the markets regard the economy administration – predominantly the Central Bank – and their correct decisions as the assurance of the economy. At the same time, they maintain this confidence even though they clearly see the signs that decisions are not made independently. They have a tendency to keep this confidence regardless of what decision the Central Bank administration makes.  

Under normal conditions, based on the data released, it is obvious that a new reduction in interest rates by the Central Bank would be a risky decision. The inflation figure of June has proven that the Central Bank’s calculation of inflation that had caused the previous reduction was wrong. Making another reduction despite this increases the risk.

Expectations high but…  

What is more, the latest inflation expectations have occurred in such a way that they demonstrate the risk of a new interest rate reduction that will be created in the economy. According to the Central Bank’s own expectation survey, the inflation rate at the end of 2014 will increase to 8.30 from 8.29 and at the end of the next 12 months from 7.27 from last month’s 7.19. At the end of the next 24 months, it is expected to go up to 6.73 from 6.62.

On the other hand, the expectation for growth of 2014 went up to 3.4 percent from the previous survey’s 3.3 percent. The growth expectation for 2015 has remained the same as last month at 3.9 percent. While the dollar exchange rate expectation for the end of 2014 remained the same at around 2.18, the expectation for 12 months later also stayed the same as the previous month’s 2.23.

The CNBC-e Preliminary Consumer Confidence Index dropped 1.7 percent in July to 79.03 compared to the final index of one month before.

In short, while inflation expectations are rising, the expected tendency to fall has not appeared yet and the Central Bank is preparing for new interest rate reductions. Maybe a small reduction will not stir up the environment too much, but it is definite that the risk is growing.