Turkey: End of the Benign Cycle in Inflation?

The results of Turkish central bank’s survey of expectations released which showed that participants were expecting to see monthly reading of 0.65% in May inflation. Having said that, the year-end CPI growth is now projected at 7.80%, 11 basis points lower when compared to the linked month. 12-month and 24-month expectations almost remained unchanged at 7.81% and 7.14%, respectively.

Turkey - Inflation Expectations - May 2016Considering the fact that a monthly inflation of 0.55% was reported in May 2015, the survey signaled the end of the benign cycle in inflation. Despite a core inflation remaining stubbornly high, the surprising decline in headline inflation painted a rosy picture for the monetary policy outlook. However, the decline was primarily driven by the base effect which now seems be not supportive anymore. Note that inflation in Turkey hit a 3-year low in April at 6.57%. Since we expect monthly CPI growth to be at 0.7% which is 5 basis points higher than consensus, the annual inflation, in our view, should hit 6.75% and finish the easing process.

Meanwhile Turkey 10-years bond is currently trading around 10%, almost 100 basis points higher since the beginning of May. The core inflation around 9.5% keeping real rates extremely low results in a need for a higher risk premium for Turkish bonds. With oil prices set to be higher for the rest of the year and the strengthening US dollar would continue to support a switch between Turkish and Russia ’43 Eurobonds since Turkey’s current account deficit will weigh on the its assets in this scenario.