Optimism in the markets based on new inflation rates

Inflation rates made a surprise in December and were below the annual inflation expectations. The market expectation was for a slight price increase, but the figures announced the other day showed that consumer prices had dropped 0.44 percent in December.

When the high rate of last year’s December is not included in the calculations, the inflation rate, which was above 9 percent at the end of November, dropped to 8.2 percent at the end of December. This drop in inflation, which is above expectations, has created an optimistic atmosphere in the markets. It was seen that the dollar exchange rate, which was climbing even in the first days of the year declined, even though slightly, and stocks started rising.

Maybe the most important effect in the markets was in the treasury bonds. While demand increased for the public debt bid that was held on the day inflation rates were announced, interest rates started falling also.

When we review the details of the inflation index that started declining in December, as well as the drop in energy prices, there were also small drops in food prices through the effect of transportation costs associated with oil. The core inflation rate, which excludes energy, food, tobacco products, alcoholic beverages and gold prices, also went back to 8.7 percent. This situation shows that the recovery in inflation is spread to the general and this increases hopes for the future.

It is expected that in the second quarter of the year, especially because of the high rates at the same period in 2014, the decline in inflation will speed up. Then, it is expected to increase and complete the year around 7 percent. This means an inflation rate that is even below the government’s targets.

In association with the inflation, the expectation in the markets that the Central Bank will decrease interest rates has started rising. Especially in the second quarter of the year, before the elections, serial cuts in interest rates are expected. This corresponds to a profit opportunity in treasury bonds and for this reason, with increased demand for treasury papers, it is creating an expectation that interest rates will go down. In other words, it is estimated that there might be foreign interest for treasury papers for profit.

Foreign exchange rates

It is uncertain how long this optimistic atmosphere will last. Personally, I think this optimism may be short, in connection to developments in the global market. However, in such a critical year, if the inflation rate falls as much as the expectations, then again it would be a very positive development in terms of the economy.

The biggest obstacle in front of optimism, however, is the foreign exchange rate movements, especially the expectation in the dollar exchange rate. Indeed, world oil prices are also important, but the positive domestic effect of the low oil prices will be curbed as exchange rates go up.

In the event that foreign exchange rates increase, it will also be very difficult for the Central Bank to make serial interest rate cuts. Despite the new measures taken by the Central Bank, its available reserves are not at a level that would prevent the rates from climbing. Thus, the climb of especially the dollar exchange rate, in connection with the expectation of the Fed’s interest rate increase, is the biggest obstacle in front of the recovery in the Turkish economy.