Turkey Poised to Reach Worst of Inflation With Peak Close to 75%

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(Bloomberg) — Türkiye hopes it is on the cusp of turning the page on another crisis as inflation rises.

The long period of annual price increases is a legacy of ultra-loose monetary policy, fiscal generosity, and chronic lira instability. Before the potential turnaround began, inflation approached 75% in May, according to the median estimate of economists polled by Bloomberg, after being just under 70% the previous month.

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The trajectory of prices that peaked in May follows the path charted by the central bank as it has embraced more conventional economics since President Recep Tayyip Erdogan's re-election a year ago. The question now is whether inflation will closely match expectations on its way down and set the stage for lower interest rates after a strong cycle of monetary tightening.

Policymakers expect Turkey's inflation rate to reach 38% at the end of the year, which would make it the sixth fastest growing country in the world, according to the International Monetary Fund. Bloomberg Economics expects annual inflation to fall by 10 percentage points in July and August.

“Although 38% is not impossible, it is very ambitious,” said Daglar Ozkan, an economist at Is Investment, which forecast a 38% increase.

The central bank says a significant deviation from forecasts and projections could lead to another rate hike, after a cumulative tightening of more than 40 percentage points in less than a year took its benchmark to 50% in March.

Official borrowing costs remained temporarily at a standstill at the last two meetings, although policymakers introduced measures to restrict loan growth and remove excess liquidity from the market to ensure financial conditions remain constrained.

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What does Bloomberg Economics say…

“Our base view is that the central bank will keep interest rates at 50% through the third quarter of this year, with any threats to the inflation path managed by tightening its alternative tools. We expect the central bank to start cutting interest rates in the fourth quarter.

— Silva Bahar Baziki, economist. Click here to read more.

Another poll of economists showed that monthly price growth, the central bank's preferred measure, was likely barely changed since April and reached nearly 3% in May. The central bank expected to see a “relatively flat path in the underlying direction of inflation” last month, but warned that energy would have a “marked impact,” according to minutes of its latest interest rate meeting.

Under Erdogan's pre-election promise, Turkish households received a limited amount of free natural gas for a year, a giveaway that ended last month and is likely to contribute to the higher inflation reading.

Looking ahead, the government's planned fiscal adjustments to complement monetary tightening will increasingly be a key factor in determining the path of inflation in the coming months.

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Ozkan said that getting through the temporary wage increase in July should be a “necessary element” to keep the slowdown on track. “Further fiscal tightening through public spending cuts would help ease the burden on the central bank.”

The momentum of declining inflation will also determine investor demand for Turkish assets, following the recent rise in foreign inflows.

Increased fiscal discipline and continued tight monetary policy should increase interest in local government bonds once there is “further improvement in inflation expectations,” according to Tovan Cummert, director of global markets strategy at BBVA in London.

– With assistance from Joel Renneby.

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