Turkey: CPI inflation expectations rise

It seems that price increases will remain on the agenda in an environment where inflation becomes more unstable, erodes purchasing power and expectations. In June, the effect of price hikes based on commodity prices, import prices, exchange rates and these increasing costs, which cause inflation instability, will increase higher inflation rates. In this context, we expect the upward trend in June inflation to be announced and reach 76.9% on an annual basis. Consumer price inflation reached its highest level in 24 years with 73.5% in May, reaching almost 15 times the target of the Central Bank of the Republic of Turkey. On the other hand, it is seen that the government and the economy administration do not want to increase interest rates at a point where they prioritize growth targets and the implementation of a new economic model, rather than tightening that can help cool down inflation.

It does not seem possible for the central bank to trigger a new policy move to stop inflation. Since the beginning of 2022, the policy rate has remained at 14%, while the policy rate adjusted for inflation has been 59.5%. As a result of the expected increase in inflation in June and the lack of monetary policy against it, the negative real interest rate effect will deepen even more and will continue to be the lowest among the major emerging markets.

The war in Ukraine caused Turkey’s energy costs to rise. This will now be reflected in the invoices as of June. While Botaş has increased the natural gas prices for households by 30% as of June 1; EMRA increased electricity prices for households by 15%. While the weight of the natural gas fee for residential use in the inflation basket is 1.55%, the weight of the electricity fee is 2.32%. While the 30% hike in the natural gas residential tariff will affect June inflation by 0.46 points, the 15% hike in the electricity residential tariff will have an upward impact of 0.35 points. We estimate that natural gas and electricity price hikes contributed 0.81 points to annual inflation in June. When we take into account the indirect cost effects of the increase in industrial consumption and the increase in electricity production, which is separated from it, the total inflation effect will be even higher. We think that the inflation effect of the government’s decision to limit the rent increase to 25% will be quite limited.

The deterioration in inflation expectations continues. Instability and volatility in inflation also affect future expectations such as 12-24 months. Market inflation expectations point to CPI increases more than four times the Central Bank’s target two years later. The central bank had raised its year-end inflation forecast to 42.8% in April. Our projections for the coming years and this year point to higher expectations for inflation. For this reason, we expect the Central Bank to update its projections upwards again in the 3rd Inflation Report of the year, which will be published at the end of this month.

Due to issues such as current dynamics, economic structure, import costs, broad policy implementations, and inflation inertia, we position the upward risks of inflation ahead. We do not expect the central bank to raise interest rates at the next July meeting, either. In the fight against inflation, macroprudential measures, TRY-based financial products to compensate for the increase in exchange rates, regulations against foreign exchange and price control mechanisms are adopted. The conditions where prices erode household budgets and cause insufficient demand shocks in the economy gain weight. In such an environment, the story of high inflation and low growth may be valid for Turkey.

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