This is the lowest inflation reading Turkey has been able to achieve in the past four decades and confirms the secular character of the current disinflation in Turkey.It therefore looks perfectly possible that the CPI headline rate can be in the 6% range by the end of the year and can get below 4% during the second quarter of next year.
It is unrealistic, however, to expect this to be an entirely linear process, and there are bound to be ups and down in store for us along the road. Indeed the year-on-year inflation rate may well increase in the next couple of months. The principal culprits here will undoubtedly be base effects and the behaviour of food prices (see below). There is also the risk emerging from higher volatility in global markets. It is not a secret that inflation — and therefore the monetary policy stance — is susceptible to change in global risk appetite through the effect of this on Turkey's exchange rate.
In Turkey, for example, food prices account for 28.5% of the CPI and thereby can turn into a major source of volatility. Over the last couple of years, food price inflation declined from 12% at the beginning of 2004 to 4.9% at the end of 2005, but then surged to 14.6% earlier this year. Although the year-on-year rate of change in food prices eased to 9.2% last month, as Serhan Cevik points out Turkey is very dependent on meteorological data and thus prices for unprocessed food still face a volatile future.
Global warming is not just about warmer weather, but also — more importantly — leads to unpredictable changes in variability patterns. One of the immediate consequences of extreme weather conditions is droughts with greater severity that cause agricultural supply shocks and higher volatility in food prices (see Stay Tuned to the Weather Channel, August 4, 2006). And we may now be observing such an event on a global scale, as the ratio of stocks to consumption dropped to its lowest reading on record, leading to a sustained increase in food prices. Indeed, virtually every country around the world has experienced a surge in food prices and consequently pressures on headline inflation rates.
Serhan Cevik, Morgan Stanley
However, a closer look reveals that there has been a sharp slowdown in private consumption (especially of durable goods that are sensitive to interest rates). In our view, all these real factors have helped in lowering durable goods inflation (excluding gold) from 3.1% at the start of the year to -2.2% in July.
Even the infamously sticky non-tradable inflation eased from 12.2% to 10.2%, contributing to the drop in the seasonally adjusted annualized inflation rate from 12.8% just a few months ago to 2.4% on the last reading (see graph below).
To get some idea of the evolution of Turkish prices over the years, here is a graph of the price index itself from 2003:
The quality of disinflation has improved in the past couple of months, as the seasonally adjusted annualised inflation rate over three months moved from 12.8% in April to 6.1% in June and 2.4% last month. Deflationary pressures on tradable goods have certainly played an important role, lowering durable goods prices (excluding gold) by 2.2% in July. Although the lira’s appreciation had an obvious effect, the key factor is still the correction in domestic demand, in our view. The growth rate of consumer spending dropped from 9.9% in the first half of last year to 1.3% in the second half and 1.6% in the first quarter of this year. No wonder, even non-tradable inflation showed a slow but steady improvement, declining from 12.2% at the end of 2006 to 10.2% last month. This is why we expect consumer price inflation to come down to 6.2% by the end of the year and then just below 4% in the second quarter of next year. However, there are early signs of recovery in domestic demand and the unwinding of carry trades could also easily turn into a source of inflation. Therefore, we expect the Central Bank of Turkey to remain on hold in the coming months and to initiate a gradual, measured easing cycle as long as the inflation trend moves in line with its target
Sehan Cevik, Morgan Stanley