Turkey’s consumer inflation rose 0.4% from April to May, bringing the year-on-year increase to 9.66%, the highest level in 25 months. The data, announced earlier this week, was hardly a surprise since the Central Bank had already warned that May inflation would be the “worst.” The markets had even braced for 9.78%, but a 1.35% monthly decrease in food and non-alcoholic beverages amid declining fruit and vegetable prices contained the rise. Prices of green pepper, tomato, sweet pea and eggplant, for instance, fell by 25% to 52%. 1
The monthly inflation in producer prices was down 0.52% in May. Core inflation — known also as “real inflation” for being stripped from seasonal and external effects — increased 1.5% in the same period, bringing the year-on-year rate to 9.77%, the highest in the last seven years. Inflation is expected to start slowing down in June and reduce pressure on interest rates. Central Bank Gov. Erdem Basci, briefing the Cabinet on June 2, said interest rates would be lowered in line with the positive inflation forecast, Prime Minister Recep Tayyip Erdogan told journalists the following day.
“The Central Bank said the interest rates will go down. We’ll see,” Erdogan said. Despite the briefing, he continued to publicly bash the bank: “I totally disapprove of their stance on interest rates. I don’t accept it. The interest rate is the cause and inflation the effect. The high interest rate is the reason behind failing efforts to bring inflation down.” Erdogan’s remarks indicate the Central Bank will be under close scrutiny in the coming days. The Sabah newspaper, known to be close to the government, claimed Basci had been given a sort of “grace period” of three months. “Basci, who presented a 53-page defense at the Cabinet meeting, was told by Prime Minister Erdogan, 'You care only about inflation, but we think of the whole economy.' Sources said the Cabinet endorsed an idea to give Basci a grace period of another quarter. Depending on the Central Bank’s monetary policy over the next three months, Plan B will be put into play,” the daily wrote. Inflation data riles Erdogan The Central Bank has struggled to achieve its inflation targets since Basci was appointed governor in April 2011, and that’s what Erdogan is using as a trump card in his attacks on the bank. In 2011, year-end inflation hit 10.4%, almost double the bank’s target of 5.5%. In 2012 and 2013, the 5% target was revised, but still year-end inflation reached 7.4% last year. This year, too, the Central Bank has revised the target from 5.3 to 6.6%. But even that figure seems out of reach.
Rate cut prospects
Under Erdogan’s pressure, the Central Bank’s Monetary Policy Committee is likely to announce an interest rate cut, if only a symbolic one, at its next meeting on June 24, despite “the year’s worst” inflation rate. Pundits expect a cut of 25 or 50 base points before the cuts begin to increase gradually in July and continue until the end of the year. The June meeting will be a hard one for the Central Bank after the record inflation figure. Yet, market trends are on its side. The bank’s policy rate — the weekly repot rate — stands at 9.5%, but the bond market's benchmark yield is already below 9%, indicating that investors have already bought the prospect for a cut of 0.5 percentage points. In comments on Bloomberg HT TV channel on June 3, Phillip Capital Research Director Ozlem Bayraktar Goksen said she saw no likelihood of a cut beyond 50 base points. Yet, fluctuations on the foreign exchange market under the impact of developments in the United States and Europe may still matter. According to Goksen, a rate cut could become even harder if the inflation rise impacts exchange rates and the Turkish lira slides to 2.20 against the dollar by June 24. What if the lira remains on an upward course? That would play into the hands of the Central Bank. The record-breaking but still better-than-expected May inflation, the prospect of slowdown in June and a retreating exchange rate will all make it easier for the Monetary Policy Committee to lower interest rates. The government, however, would not like to see the Turkish lira advance too much against the dollar. Economy Minister Nihat Zeybekci insists that a lira-dollar ratio in the 2.15-2.25 range is the best for exports. So, the government wants both a cheaper currency and lower interest rates. Cutting interest rates before beefing up foreign exchange reserves could lead to sharp fluctuations in the currency’s value. Hence, the Central Banks is seeking to boost its reserves. On May 23, the reserves stood at $130.6 billion, up by $1.57 billion from the previous week and at their highest level since Dec. 27. The Central Bank is taking precautions also for the prospect of a stronger lira. Starting from May 9, it halved the amount of its daily dollar selling auctions to $20 million. If the lira continues to advance, the bank may completely halt the selling auctions and turn to buying to bolster its reserves. In another important factor, repayment of Eximbank loans will begin in June, also contributing to boosting the reserves. In its latest review of Turkey last month, Standard and Poor’s cautioned that a decrease in reserves owing to interest rate cuts would have a negative impact on the country’s credit rating. The Central Bank appears to be paying attention to the warnings. The drive to bolster reserves seems to be a preparation for a rate cut. Read more: http://www.al-monitor.com/pulse/originals/2014/06/turkey-inflation-slowdown-central-bank-rate-cuts-economy.html#ixzz34BB1QWOs