Turkey's Central Bank Lowers Rates to 15.5%

Turkey's central bank lowered its benchmark interest rate by a quarter of a percentage point to 15.5 percent today, the fourth consecutive reduction, after the economy grew at the slowest pace in six years and inflation expectations fell.




Economic growth slipped to 1.5 percent in the third quarter, the slowest pace since a 2001 recession, after the central bank raised borrowing costs by 4.25 points in June and July 2006 to restrain inflation. Since September, the bank has lowered the benchmark rate by 2 points.



The inflation rate was 8.4 percent in December, unchanged from the previous month and more than double a year-end target of 4 percent backed by the International Monetary Fund. While drought and increases in tobacco and fuel taxes drove up inflation from a three-decade low of 6.9 percent in July, price growth will resume its decline in the medium term, the bank said on Dec. 27.




Turkey's 12-month inflation forecast fell to 5.94 percent from 6.14 percent, according to a fortnightly survey of economists and businessmen published by the bank on Jan. 9. Turkey targets inflation of 4 percent this year.

Clearly the central bank is taking the view that the risks from slowing growth and the global environment outweigh inflation concerns at this point.

The prices of unprocessed food - which have been a major part of the headache - appear to have stabilized somewhat in the last two months of 2007, leading to a reduction in the annual inflation of this subgroup. Meanwhile, despite a relative slowdown, processed food prices continued to increase at a rapid rate and the 9.8 percent increase in processed food prices in the second half of the year adversely affected the core inflation indicators. Recent data is suggesting a rather more favorable weather outlook, boding well for the future prices of unprocessed food group. On the other hand, the response of processed food prices to agricultural supply shocks is likely to persist for some time; therefore, price increases in this group may continue for some months into 2008.


Energy prices rose by 0.89 percent in December as a result of hikes in energy items
in the housing group. With these hikes, annual inflation in the energy subgroup
rose to 11.25 percent. A further rise in annual inflation in the energy sector is expected in January due to increases in the price of electricity and natural gas. The bank expect this price adjustment to contribute by 0.6 points to CPI inflation in January.

Year on year increase in the prices of goods excluding energy and unprocessed food climbed to 6.6 percent due to an uptick in processed food inflation and the base effect on the clothing-footwear group. Generally, however, the downward trend in the prices of consumer durables continued in December.

A variety of recent data indicate that the recovery in economic activity continued in the last quarter of 2007. Industrial production rose by 8.3 percent and 7.7 percent year-on-year in October and November, respectively, and the average of October-November period exceeded the third quarter average in seasonally adjusted terms. Seasonally adjusted figures on capacity utilization also suggest that the growth in industrial production continued into December.


Leading indicators on consumption and investment present a similar outlook. Domestic sales of automobiles increased by 36.6 percent quarter-on-quarter in Q4 2007 and picked up markedly in seasonally adjusted terms compared to the third quarter. The moderate growth in consumer loans continued in December. The month-on-month change in automobile loans turned positive in real terms for the first time since June 2007. Real imports of consumer goods, passenger cars and consumer durables in particular, increased significantly on a year-on-year basis in the last quarter of 2007.

Leading indicators for investment demand point to an increase in machinery equipment
investments on a year-on-year and per quarter basis in the last quarter of 2007. In the October-November period, imports of capital goods increased by 36.2 percent relative to the same period last year, exceeding the level recorded in the third quarter in seasonally adjusted terms. Following a rebound in the third quarter, sales of light commercial vehicles maintained the upward trend in the last quarter growing by 23.6 percent in annual terms and recording a discernible rise in seasonally adjusted terms over the third quarter. Meanwhile, sales of heavy commercial vehicles have declined continuously on a monthly basis since September 2007, but rose by 1.6 percent year-on-year in the last quarter. Moreover, seasonally adjusted figures on production and import of machinery-equipment and electrical machinery point to a pick up ininvestments in the last quarter.

In the third quarter, the number of construction permits, one of the leading indicators of construction investments, decreased by 10.8 percent on a year-on-year basis, while the annual growth rate of the construction sector significantly lagged behind the growth rates observed in previous periods. The diffusion index of “the probability of purchasing or constructing a house in the next 12-month period”, compiled from the Consumer Confidence Survey, has been on a downward trend since July 2007, suggesting that the slowdown in the growth rate of housing construction is likely to persist in 2008. On the other hand the significant rise in employment in the construction sector in seasonally adjusted terms which took place during the second and third quarters of the year together with the marked increase in the production of non-metallic minerals in the last quarter signal that the slowdown in construction sector may well be fairly modest.


Exports rose by 13.5 percent in real terms compared to the same period last year according to quantity indices. Early readings on December and January also point to a continued upward trend in exports. Nevertheless, the growth rate of exports was surpassed by the growth rate of imports in the fourth quarter due to recovery in domestic demand and substantial increases in imports. Therefore, the effect of net foreign demand on growth is likely to be negative in the fourth quarter. The expected slowdown in the economic activity of developed countries has increased the downside risks on the course of exports.

In the third quarter of 2007, the pace of productivity growth fell behind real wages in manufacturing industry, leading to an increase in unit labor costs. Nonetheless, the slowdown in employment and the increase in productivity gains in the last quarter of the year points to a possible renewal of the downward trend in unit labor costs in the manufacturing industry.

The lira has gained almost 7 percent against the dollar since the bank began cutting rates in September. Gains for the lira help curb inflation by lowering the cost of imported raw materials and consumer goods.