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Turkey: Record inflation unlikely to be enough to increase the rates

by ozsozhaber

Inflation in Turkey rose to 48.7% in January, its highest reading since 2002. Broad-based and multi-component inflation illustrates the spillover effect of the main drivers weak lira and high energy costs. On the other hand, although extremely high inflation sends real yields to non-standard levels, price instability is considered temporary by decision makers and therefore, a move towards a rate hike is strictly avoided. Therefore, real returns, which are by far the lowest among leading emerging markets, are unlikely to trigger a policy reaction against inflation at this stage.

 

After the high periodic realization in December, the fact that the monthly change was at a record level of 11.1% in January shows a serious spillover effect. The very high periodic increases in inflation in the following months also reveal that the pass-through of the phenomena that raise prices is not over yet. The first of these is the exchange rate pass-through. Due to the inventory turnover period, the reflection of the exchange rate decreases on the costs cannot be realized quickly, and the unstable inflation expectations make the determination of new prices on the basis of the uncertainty of the lira and the cost that can be endured in inventory replenishment uncertain. This causes price decreases not to be reflected, the potential for pass-through from PPI remains high, and a sticky effect on inflation. We think that these effects will continue in the coming months.

 

If we look at the sub-items of inflation; An increase is observed in almost all of the main expenditure groups. There was an increase in the average prices of 354 out of 409 modules, and in general, there is an inflation effect that spreads above both seasonal averages and expectations in almost all items. The contribution from food prices is still at its most prominent point; The periodical increase of 16% in December was followed by a high change of 10.9% in January. In terms of its contribution to general inflation as a payroll, it is the most important factor in the rise of the annual inflation band. Considering that central inspections to control food prices have also been tightened, this effect is significant. Because seasonal factors and imported-based agricultural inputs are primarily effective in the price increase here.

 

According to Indicator B, which excludes energy, unprocessed food, alcoholic beverages, tobacco and gold, annual prices rose to 42.7% in January from 35% in December. Alcoholic beverages and tobacco stand out with 21.90%, housing 18.91%, household goods 12.82%, health 11.27% and transportation 11.15% as items that showed higher increases than headline inflation. The narrower C indicator, which excludes volatile items such as food and energy, rose to 39.5% in January, reflecting the cost pressures on core goods and services, especially due to exchange rates. On the PPI side, the increasing impact of raw material prices, increased production costs along with electricity and natural gas hikes, and the operating cost impact of high wage increases caused the upward pressure to be updated. On the producer inflation side, we see a periodic increase of 10.5% and a realization of 93.5% from 79.9% on an annual basis. In the coming months, we will continue to observe the increasing effect of the cost factors we mentioned on PPI, which will require us to look at the event from the PPI-CPI pass-through effect.

 

As the effect from the weak lira continues, we are faced with a serious inflation spillover effect due to the effects of high energy costs, both the effects of global prices and the price hikes. Minister of Treasury and Finance, Mr. Nureddin Nebati’s latest statements include his assessment that we will see the peak in inflation in April. This shows that the high inflationary effects of January will be felt in the months encompassing 1Q22 as well, and that we will continue to see the effects of the fight against inflation. Therefore, it is very possible to see bands above 50% in inflation in the 1Q22 period. Afterwards, there will be a decrease and this will be mostly due to the base effects of the previous year towards the end of the year. The stability of the lira must be maintained so that this predicted path in inflation does not deteriorate. In terms of the continuation of the stable band that has been established in the exchange rate since the end of December, we have to observe the effect of financial instruments containing TRY investment incentives, under the assumption that there will be no reaction in the main policy instruments. We think that under current conditions, the decline in inflation will not materialize significantly until 4Q22, when the base effect will prevail, and the risks of upward deviations in the forecast path during the year are ahead.

 

With the recent rise in inflation, Turkey’s real interest rate (one-week repo rate minus inflation) has deepened into negative territory, a level that is very inconsistent among major emerging markets at -34.7%. President Mr. Recep Tayyip Erdogan’s economic doctrine is that high borrowing costs cause inflation. That’s why he thinks lower, rather than higher, interest rates are necessary to combat high price increases and rising cost of living. As a matter of fact, lira interest rates, which are well below inflation, increase the inflation-induced erosion effect on savings, and this directs the people whose purchasing power has decreased to more foreign currency in order to protect themselves from inflation. The said factor, with its declining effect on the lira, increases the inflation effect stemming from the exchange rate pass-through. In order to overcome this situation, the government recently introduced the currency-protected deposit product, which was planned to encourage lira savings, and committed to compensate the losses of citizens and corporates in case the exchange rates increase more than the promised bank interest rates.

 

The Central Bank estimates that the inflation will reach the 50% band in the first half of this year, and will end the year at 23.2% with a downward trend in the remaining part. We assume that the CBRT will not follow a tight policy within the framework of these conditions and economic objectives in the current inflation plane, so it is unlikely at this stage that policy makers will react with an orthodox mechanism with rate hikes against rising prices.

Kaynak Tera Yatırım-Enver Erkan
Hibya Haber Ajansı

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