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.
Considering 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.
Turkish MPC remained on hold once again yesterday as one-week repo rate, or so-called policy rate stood at 7.5%, along with overnight lending and borrowing rates at 10.75% and 7.25%. The central bank for sure will maintain the status quo until the end of Basci’s term in April.
“Tight monetary policy stance will be maintained” part of the guidance was also once again preserved. CBT lifted its average cost of funding recently which has been slightly above 9% since late January to that end. However, with double-digit core inflation rates, it is still hard to admit that CBT is on its way to achieve its long-term inflation guidance.
On the latest survey of expectations report we saw forward inflation expectations still way above the targeted inflation rate of 5%. CBT has already guided for achieving the target in 2018 earliest.
Interestingly, while maintaining a “tight” monetary policy stance, M2 money stock has been consistently growing, in other words, CBT has appeared to be pursuing a quantitative easing.
Anyone should be dwelling upon consequences henceforth.
After Turkish lira bounced back from its record low of 2.74 to 2.58 versus the US dollar, it is stated by some pundits that more rate cut may be on the way from Turkish central later this year with a scenario of serious slowdown in economic activity. On its May meeting the central bank decided not to change the policy rate or the parameters of the so-called interest rate corridor in line with the market consensus. Unfortunately in its monetary policy committee statement CBT emphasized that the developments in the core inflation front will be limited due to the volatility in foreign exchange market. In my view a rate cut is a fantasy, not just because of the US Federal Reserve concerning a rate hike in the upcoming months, but of inflation dynamics in Turkey still draw a gloomy picture. The aforementioned sentence from the CBT’s statement was also the only part the changed from the previous report, making it the most important point to gleam.
The chart below highlights the trends in the top inflation indicators of the country. The headline inflation has been on a rising trend since January when CBT cut the rates amid political pressure resulting in the loss of credibility. Conversely core inflation has been easing, however, CBT sees no further development in the general price level indicator.
According to the survey by CBT the decision makers in Turkey see a higher inflation rate within a 12-month horizon, and more interestingly, one-week repurchasing agreement rate, or so-called policy rate, is expected to be higher within the same horizon. CBT will likely will be shifting its focus increasingly towards the high rate of core inflation as a reason to hold off cutting rate for some time to come.
Market participants as well as politicians will question the implications that higher interest rates would have on future growth prospects. Turkey has been recording underwhelming economic results and lowering interest rates may seem like a tool to put Turkey back on a growth path. This simplistic view that ignores seeing structural reforms as the real solution Turkey’s below par growth issue was primary reason behind the unbalanced and unsustainable growth path that the country entered following the global financial crisis. On the other hand it may lead CBT to rise the interest rates by another 500 basis points to defend the local currency as the emerging market currencies will start to fade as a consequence of the US Federal Reserve officially tightening. Shortly CBT is between two fires.