Guldem Atabay
Feb 07 2018

No, Turkey’s January inflation is not good…

Turkey's January consumer price inflation of 1.02 percent month-on-month has pulled 12-month CPI down to 10.3 percent from 11.9 percent in December.  Last year’s very high January figure was fueled by depreciation in the lira and food prices. So the current decline has roots in the base-year effect as well as very tame looking food price inflation.

Twelve-month food price inflation slid rapidly to 8.8 percent in January from the previous month’s 13.8 percent, thanks to favorable weather conditions that capped unprocessed food prices.  In fact, the contribution of the “food and beverage” sub-category of inflation to headline CPI has eased to 0.4 percentage points this year, comparing very favorably with last year’s 1.4 percentage points, therefore yielding a full percentage point drop in the headline inflation rate.

Similarly, domestic producer price inflation recorded a 0.99 percent month-on-month increase in January, pulling down the 12-month rate to 12.1 percent from 15.5 percent a month ago. 

With headline inflation on the decline, market participants hailed the figures as a positive step. Still, the jubilation had a limited effect on the lira and Turkish treasury yields.  After all, the inflation rate remains in double-digits, contrasting strongly with the emerging-market average of 3.5 percent.

Turkish January inflation

The unease of course is due to insistently high core inflation that plagues the future path of overall inflation once the positive effects of the base-year effect diminish.  This so-called C-index saw a very limited drop to 12.2 percent in January from December’s 12.3 percent, despite the asymmetrical 157 basis point decline in headline CPI.

When looking at the details, it is quite interesting to see how core inflation is resistant to recent lira appreciation, which resulted from the dollar’s global weakness in January.  This could have created room for a significant decline in core inflation rates in the months ahead which should have been priced in immediately.  Yet, such an eventuality is only possible if the majority believe the lira’s current level is sustainable for the remainder of the year.

Moreover, while producer price inflation looks to be moving in tandem with exchange rate movements as lira appreciation eases cost side pressures, consumer price inflation appears to be detached from currency movements.  In figures, while twelve-month “service price inflation” eased to just 9.2 percent in January from 9.5 percent in December, twelve-month “goods inflation” posted a stronger drop to 10.8 percent from 13 percent a month ago.

CPI
CPI2

This can only be explained by the strength of the deterioration in inflation expectations as the central bank keeps failing to deliver on its 5 percent annual inflation target and core inflation remains fixed in double digits.  As inflation inertia shows its ugly face again, no wonder the Turkish people rush into banks to increase their hard currency deposits to record levels each week. Dollarization in the economy is once again on the rise, weakening already incompetent monetary policy.

Looking ahead, the January inflation readings are hardly a cause for comfort.  To begin with, higher oil prices -- heading to $80 a barrel -- will feed into higher emerging-market energy price inflation over the next few months.  Turkey, as a net energy importer, will surely get hit by higher oil prices, both through inflation and a wider current account deficit. 

Of similar importance, food and core inflation are set to rise in some major emerging markets, including Turkey.  Emerging-market inflation, which remained steady in the final few months of last year, in contrast to Turkish inflation, is set to drift upward over the course of 2018.  Thus, following a few months of favorable base-year effects, Turkey’s inflation rate hardly looks destined to slow into single digits on a sustainable basis.

inflation
inflation

Further complicating the inflation outlook for Turkey is that core inflation is way above headline CPI inflation. This means that cost-side pressures are far from easing despite the lira’s recent bout of strength. This fact should of course remind everybody that apart from the base-year effect and temporary price adjustments, inflationary forces in Turkey are hardly losing steam.  Beyond the first quarter’s base-year effect, which might pull down headline CPI into high single digits, inflation is set to float in the 10-12 percent range during the second half of the year.

When it comes to the value of the Turkish lira, expectations are for a rate of 4.1-4.3 per dollar by the end of 2018. In fact, as Fed rate hikes unfold throughout the year -- a fourth increase is now on the horizon -- the spike in U.S. Treasury yields will create significant volatility in the currency markets, especially in emerging market currencies as money flows back into safer havens.

Lira depreciation always creates more inflation in Turkey, as observed clearly in the past two years, and will put upward pressure on cost-side inflation. This will be especially evident so long as the central bank refrains from doing what is necessary to combat high inflation, under pressure from a government that mistakenly sees higher interest rates as the main cause of inflation. 

inflation
inflation

Last but not least, we know for sure that with elections approaching, the government will do all it can to keep stimulating the economy.  After 7 percent GDP growth in 2017, the government now considers its 5 percent growth target for this year insufficient to keep employment rates, thus votes at the ballot box, intact. To achieve such an aggressive growth rate, the government must of course use more public money to stimulate the economy.  As was the case last year when consumer price inflation peaked at 13 percent in November because of government support for economic growth, similar measures will no doubt create new inflationary pressure. And all this in an economy where anchoring inflation expectations is already a lost cause due to the central bank’s insincere inflation targeting scheme.

As a reminder, in its first inflation report of the year, the central bank has raised its year-end estimate for consumer price inflation by a full percentage point to 7.9 percent.  With likely domestic and international dynamics heralding stronger price pressures, there is little need to say that the central bank’s outlook for inflation is no more than wishful thinking and hurts its credibility even more.

Insisting that it is following “tight” monetary policy, the central bank is very unlikely to ease banks’ average funding costs, currently hovering at around 12.3 percent, even as headline inflation eases in the next two months. Unless, of course, it bows to mounting political pressures that once again surfaced when its governor was called to the presidential palace last week. Any premature easing in funding costs would be a disaster for inflation, thus we should be safe in assuming that the bank will keep rates at current levels until core inflation eases significantly. 

Yet again, the central bank is hardly likely to do what it should to cap inflationary forces -- hiking interest rates proactively.  As inflation will be left to its own devices, all of the aforementioned factors will mean double-digit CPI inflation at the end of 2018, again.

In short, there is no need to get excited about a likely slide in headline inflation during the first quarter because ongoing trends, combined with central bank inaction, mean no happy ending for inflation in 2018.