Turkey: Acceleration in inflation and the condition of the lira increase the risk of a spiral

Annual inflation in Turkey increased from 70% in April to 73.5% in May, its fastest rise since reaching triple digits in the 1990s. We observe that inflation, which was 2.98% on a monthly basis, slightly above our 2.4% expectation and below the market’s overall 4% expectation, at the level of 2.98%, explains the divergence as a moderate increase in food prices, which we can call the expected. The weak lira and rising commodity prices stand out as the main drivers of inflation.

If we look at the sub-items of inflation; The increase is broad-based and covers most components. While food prices increased by 1.63% on a monthly basis, it is seen that the 11.1% decrease in fresh fruit and vegetable prices and the 1.83% decrease in the unprocessed food side were effective in the sub-item of this item. Food and beverage prices increased by 91.6% year-on-year. The CBRT’s year-end food inflation assumption is 49% with the latest revision, but considering the current price developments, especially the problems on the global supply side and the continuous increase in agricultural input prices, it is very difficult for food inflation to drop to this point. A very effective set of measures has not been implemented in terms of food and agriculture, either in supply conditions.

Transport costs more than doubled due to energy. In May, periodic energy inflation was 2.9%, while the annual rate of increase rose from 118.2% to 121.2%. The continuation of the increase in global energy prices prevents the cooling of the inflation effect in this item. We will see the effect of the recent natural gas, electricity and gasoline price hikes in June inflation. While the 30% increase in the natural gas housing tariff will affect the June inflation by 0.46 points, the 15% increase in the electricity housing tariff will have an upward effect of 0.35 points. Thus, the total effect of natural gas and electricity price hikes on June inflation will be 0.81 points directly. When we take into account the indirect cost effects of the increase in industrial consumption and the increase in electricity generation separated from it, the overall inflation effect will be even higher.

Producer prices increased by about 8.76% during the month, bringing annual producer inflation to 132.2%. This indicates that the cost pressure on the CPI will increase in the coming months. The fact that the PPI is very high and this has not been reflected yet stands out as one of the major problems on inflation. Although the PPI – CPI pass-through does not occur at the same rate, there is a pass-through effect on consumer prices depending on the demand situation. In such a high inflation environment, consumers push demand forward. Thus, both a cost problem and demand inflation occur on the supply side, and these two components affect each other, throwing inflation into a spiral, where it will not stop. This situation feeds the risk of a hyperinflationary environment like the 80s and 90s.

The core inflation index, which excludes the impact of volatile items such as food and energy, rose from 57.2% to 61.6% in the CPI-B indicator, and from 52.4% to 56% in the CPI-C indicator. When we look at the details of the basic goods and services that make up this, it is seen that the cumulative pass-through effect of the exchange rate and the demand situation explain the intense price increases. We are watching the effect of increasing activity and demand in service prices after the epidemic, as well as the effect of rapid increase with the effect of exchange rates. Alcoholic beverages and tobacco were 6.53%, entertainment and culture 6.15%, restaurants and hotels 5.47%, clothing and shoes 4.64%, transportation 3.43%, household goods as items that showed higher increases than headline inflation.

Inflation is almost 60% above the benchmark interest rate, by far the widest gap between major emerging markets. The profoundly negative state of inflation-adjusted interest rates reduces the attractiveness of holding Turkish assets. Plus, the fact that Turkey is not involved in the global monetary tightening trend led by the Fed, unlike many central banks, will have a deeper impact here.

The rise in the exchange rate, the rise in oil and energy, and the effect of very high prices on the food side despite the summer season will cause inflation to not decrease. The pressure on the lira is increasing, and its recent performance is the worst among emerging markets. There is no sign of a decrease in rising commodity prices either. The ongoing increase in international markets in oil and energy will be reflected in producer prices.

If we look from the perspective of the central bank; The inactivity of the monetary policy causes ineffectiveness in the fight against inflation. The statements of both the Central bank and the economy management show that rate hikes are not evaluated in any way, and that the liraization strategy, which includes collateral, liquidity and macroprudential measures, will be used, as stated in the MPC summary. FX-linked deposit was a tool that included investment incentives in lira and aimed to provide conversion from foreign currency. Although it contributes to the stabilization of the exchange rate for a while, the rocketing in inflation and the increase in the exchange rate may cause CPI indexed products to be offered to protect against inflation or to introduce TRY-based alternative products. If the rate hike had taken place early, or if the central bank had maintained its pre-September position before inflation soared, these effects would probably not have been so profound.

The central bank will hold its next MPC meeting on June 23. We do not expect any rate changes at this meeting either. In an environment where monetary policy is not used in any way, it is seen that there is no effective ground in the fight against inflation, except for some price measures announced by the government. Increasing interest rates was not evaluated in any way, and President Mr. Recep Tayyip Erdogan’s views also suggest that there is no meaningful relationship between reducing inflation and interest rate policy. We think that an effective monetary tightening in the short term and a structural program and planning that takes the fight against inflation as the main objective in the broader term are needed to get out of the current inflation cycle.

Inflation is still in a rapid upward trend and together with the deteriorated expectation channel, the impact and inertia felt by the situation reflected in the pricing behavior are also increasing. In addition, high inflation and the weakening of the lira create a spiral effect that feeds each other. We think that the effect of inflation will continue until the end of the year and we do not expect it to fall below the 70% path. The expected base effect will be possible in the last month of the year. We expect to close this year with an inflation rate of 65%.

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