Why is inflation picking up again in Turkey?

Inflation in Turkey began to accelerate again, despite the change of financial authorities in the country and the beginning of a cycle of raising interest rates. According to TurkStat data published on August 3, consumer prices rose by 47.83% in annual terms in July after 38.21% in June. The biggest contribution to Turkish inflation was made by prices for hotels, cafes and restaurants (an increase of 82.62% y/y), healthcare (75.95%), food (60.72%) and education (53.57%). Compared to June, prices increased by 9.49%, the largest contribution to the monthly dynamics was made by transport – transportation services rose in price by 17.75%.

On June 22, the Turkish central bank raised its key rate from 8.5% to 15% for the first time since 2021. Despite the almost two-fold increase, analysts considered the regulator’s move to be weak. Lyra reacted accordingly. By the beginning of July, it weakened against the dollar to another historic low of 27 lira per dollar. On July 20, the regulator raised the rate again – to 17.5%, which stopped the fall of the national currency, but did not lead to its significant strengthening: the dollar has not traded below 26.9 lira since the end of the month, according to Bloomberg data. Both increases in the key rate of the Turkish Central Bank were significantly lower than market expectations, which expected it to rise to at least 21% – closer to inflation levels in May – June.

The wave of inflation in Turkey began in November 2020, when the rate jumped from 11.89% in October to 14.03%. In March 2021, prices accelerated by 16.19%, in June – by 17.53%, in September – by 19.58%. Another sharp jump occurred at the end of the year, when December inflation was 36.08%. In early 2022, it accelerated even more, reaching 48.69% in January, 54.44% in February, 61.14% in March and 69.97% in April. In October, prices rose by a record 25-year 85.51%. From that moment on, inflation began to decline and by January 2023 it had already reached 57.68%. The downward trend continued in the spring, in May the indicator overcame 40%, this level persisted in early summer. In June, Turkish inflation slowed to an 18-month low of 38.2% year-on-year, according to TurkStat data released on July 5.

Turkish President Recep Tayyip Erdogan, who won the second round of elections on May 28 and was re-elected for a new term, on June 3 appointed a new finance minister, Mehmet Simsek, and on June 9, the head of the Central Bank, the first woman in this post, Hafize Gaye Erkan. Both Shimshek and Erkan had previously worked in Western financial institutions (the former at Merrill Lynch, the latter at First Republic Bank) and were known for their orthodox view of monetary policy, prescribing to raise rates amid high inflation. In fact, their vision did not coincide with “erdoganomics” – the ultra-soft policy that the Turkish president adhered to.

On August 3, Shimshek, after the publication of data on the acceleration of inflation in July, assured on his Twitter account that this was in line with market expectations. At the same time, according to him, thanks to the recent efforts of the Central Bank of Turkey on disinflation, including raising the rate, annual inflation will begin to decline from mid-2024. Simsek stressed that the economic bloc of the government will support the process of disinflation through fiscal discipline, and the ultimate goal of the Turkish authorities is reducing inflation to single digits “in the medium term”. On August 4, Shimshek will meet in Istanbul at the Turkish Economic Forum organized by JPMorgan with representatives of 50 foreign investors in the Turkish economy, including BlackRock, JPMorgan, Singapore Wealth Fund and Franklin Templeton. The head of the Central Bank Erkan will also speak at the forum.

The main reason for the acceleration of prices in Turkey was that the market’s expectations about the key rate at least at the level of the current annual inflation did not come true, both increases were rather a decorative reassuring step for foreign investors, Andrey Kochetkov, a leading analyst at Otkritie Investments, believes. Turkstat data also confirms the significant influence of seasonal and market factors: summer is the tourist season, high demand pushes prices for rental housing and services, including catering, to rise, the expert says.

Inflation in Turkey is very closely linked to food prices, the rise in grain prices this summer, in particular wheat, had a very tangible impact, Kochetkov points out. So, at the stock exchange in Edirne on July 3, prices rose from 5.7 lira per bushel (38.6 kg) to 7.5 lira. Strong inflationary pressure in this case was exerted by the reduction in shipments of Russian grain in July: they fell by 22% to 518,000 tons, it was reported on July 31 in the monitoring of the Russian Grain Union, Kochetkov said. It could rise even further as Russia pulls out of the grain deal, he adds.

The traditional contribution to inflation in Turkey is made by fuel prices, and in this country, which does not have a significant production of such raw materials, they are tied to the conjuncture of foreign markets, Kochetkov notes. Meanwhile, until the end of July, oil rose for five weeks in a row, and on July 31 it traded at a maximum for three months: the September futures for Brent was estimated on the London ICE exchange at $84.99/bbl. This continued until August 2, when Brent October futures fell to $83.2/bbl (-2%) for the first time.

At the moment, the financial authorities of Turkey are frantically trying to change their policy in order not to allow the consequences of “Erdoganomics” to grow in full force, said Sergey Demidenko, Dean of the Faculty of the School of Political Studies of the RANEPA. In theory, this approach involves fighting inflation by reducing the key rate to a minimum so that the most favorable conditions are created for business and it can increase production and the number of jobs – this would accelerate demand in the country and inflation should slow down, the expert explains. This, however, did not give the expected result, inflation has accelerated rapidly since 2020, Turkey most likely will not have a quick and painless way out of this situation at the moment, concludes Demidenko.

How long Turkish inflation will accelerate depends heavily on the dynamics of world prices for raw materials, including food, and therefore on the status of Russia’s participation in the grain deal, Valery Yemelyanov, an expert on the stock market at BCS World of Investments, points out. It is also difficult to say what actions the Turkish regulator will take in this case, he adds. If, as expected, he will bring the rate to 30% by the end of the year, the trend in inflation may again turn towards its slowdown, the expert admits.

Erkan, the head of the Central Bank, has the determination to cope with high price growth, so the duration of the disinflation cycle depends more on the ability to convince Turkish citizens that macropolitics has become much tougher, Oleg Shibanov, head of the Sberbank Center for Macroeconomic Research, said. With inflation of more than 40%, loans at not the highest rates are beneficial to citizens, so limiting demand will not be easy, most likely, price reduction will take years, he said. Meanwhile, household debt load is not only low (11%), but has been declining in recent months, the expert adds.

Probably, in the current situation, inflation will fluctuate in the range of 40-60% until the end of this year, Yemelyanov believes.

Back in the fall of 2022, official inflation was at the level of about 85%, such values ​​can be presented as a limit in 2024, Shibanov believes. Until the end of 2023, price growth should remain at around 50%, he adds.