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Turkey condemned to double-digit inflation until Kingdom Come

An article by Demon H. Grande

Turkey condemned to double-digit inflation until Kingdom Come

Turkstat announced a bitter surprise for inflation-wary citizens of Turkey on 3rd of November. In October final prices rose by 2.08% MoM, with annual CPI hike reaching 11.9%, or the highest since the crisis of 2008. Producers fared worse. The prices they fayed/charged rose by more than 17%, or the highest annual increase since 2004. Turkey’s monthly double-digit inflation is not temporary, or driven by a specific transitional factor. The “core” price index which describes the trend rose from 11.0% to 11.8%, underlining the bitter fact that it will be very, very difficult to suppress inflationary trends and expectations.

Needles to say, Turkey’s 2 and 10 year government bond yields immediately jumped by 8 and 6 basis points, respectively reaching (on an annual, compounded basis) 13.12% and 11.96%, both multi-year highs. Dollar/TL shot up to near 3.83, while the more accurate description of the exchange rate, the Currency Basket was trading around 4.14, near 2017-highs, awarding TL the dubious honor of becoming one of the weakest EM currencies of the year.

You would expect the Central Bank of the Nation, CBRT to become infuriated by these developments and take immediate action, or at least threaten prompt action. After all, at the top of its official website, it is inscribed:

“The primary objective of the Bank is to achieve and maintain price stability”.

In small print you will read price stability is defined as 5% annual CPI inflation give or take 2%. Hello, CBRT, where art thou, my White Knight in shining armor?

Strangely enough, two days before the inflation data release, its chairman Mr. Cetinkaya spoke at the introduction of the quarterly Inflation Report, hinting at “negative inflation surprises in October and November data”, expressing concern about deteriorating price trends, but only upgraded 2018 CPI forecast to 7%. To give our readers a perspective, participants in CBRT’s own monthly survey forecast 8.50% in 12 months. Even in 24 months, participants don’t expect inflation to decelerate to 7%. The mean prediction is 7.98%!

Why is CBRT playing the Three Monkeys? I mean after all, if the government is to be believed, growth in 2017 will reach or exceed 7%. CBRT doesn’t have to fear a slump, if it were to combat inflation with tighter monetary policy. The answer is simple. The president of this Great Nation, Mr. Recep Tayyip   Erdogan firmly and devoutly believes that higher interest rates lead to higher inflation. At a more pragmatic level, his best buddies, the real estate and construction lobby is already squeezed by soaring costs and drooping prices, pressuring him for lower mortgage rates. CBRT might be nominally independent, but we all know after the fear God, fear of Erdogan rules this country. There shall be no rate hikes lest The Great Boss blesses them.

Until now “traditional economists”, i.e. those who still believe that CBRT was capable of making independent policy believed that if inflation were to get out of control, CBRT would respond by tighter policy. As of the October inflation data release, that hope has gone the way leisure suits and latex kimonos. Market strategists, a more realistic bunch, knew CBRT would never hike rates, but counted on seasonality and a slower domestic demand driving down headline CPI at the turn of the year, which would allow CBRT to claim victory and cut the effective funding rate (the daily blended average OMO rate). They piled into bonds. That hope, too, is now dead. Given a core inflation of 11.8%, there is no wait in hell short of strict monetary or fiscal action, headline will decelerate to single digits in the next few months. Bond yields will march upwards, too.

Yet, this is not the worst news. Turks hold most of their financial wealth in short-term savings deposits. The duration could be as low as 3 months. For small savers, the net annual yield on these deposits is 12%, for “whales” 14%. It just doesn’t make much sense to linger in TL assets, when double digit monthly inflation is eroding the value of wealth on a daily basis, while spot volatility of the exchange rate is rising. Turkish retailers sold $7 billion of F/X in the last 6 weeks, now they’ll start buying again, exerting downward pressure on the exchange rate. A weaker exchange rate immediately spills over to higher core prices, and within 2 months to higher CPI.

Turkey has reached the stage where currency depreciation and inflation are creating a vicious circle. The only hope is a miraculous decline in the Dollar Index and/or American bond yields which would push more money into risky assets like TL, which would save the winter. Otherwise, Turkey will have double digit inflation until Kingdom Come.


Demon H. Grande

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