An upward revision in inflation forecasts obscures the next policy step

At the 3rd Inflation Report meeting of the year, the CBRT increased its year-end inflation expectations from 7.4% to 8.9%. In the forecast revision of the Central Bank, the main basis is rising oil and food prices, but it also indicates that inflation will remain above the policy rate in the current conditions. Inflation expectations for 2021 have been updated from 5.4% to 6.2%. Food inflation expectation was revised from 9.5% to 10.5% compared to the previous estimate for 2020. The Central Bank has also increased its average oil price forecast from 32.6 USD to 41.6 USD after the price developments since the previous reporting period.

At the 3rd Inflation Report meeting of the year, the CBRT increased its year-end inflation expectations from 7.4% to 8.9%. In the forecast revision of the Central Bank, the main basis is rising oil and food prices, but it also indicates that inflation will remain above the policy rate in the current conditions. Inflation expectations for 2021 have been updated from 5.4% to 6.2%. Food inflation expectation was revised from 9.5% to 10.5% compared to the previous estimate for 2020. The Central Bank has also increased its average oil price forecast from 32.6 USD to 41.6 USD after the price developments since the previous reporting period.

 

The Central Bank revised its inflation expectations upwards as expected after high inflation and deviation from forecasts in the 2Q20 period. On the other hand, we can say that the year-end inflation expectation, which is 8.9%, remains optimistic compared to the market expectations that have increased to double digits (CBRT Expectations Survey: 10.2%, Tera Investment: 10%). After the pandemic, supply-driven pressures on inflation appear to be longer, but the demand-driven situation is not expected to extend over the long term. However, even if the demand factor is temporary, the depreciation that started to come to the fore again in TRY is able to increase inflationary pressure in terms of costs. Credit expansion also finds its place in the inflation equation due to its demand effect and was one of the factors affecting inflation to rise 12.6% in June. In inflation, even if one of the factors that have an upward effect is eliminated, it appears to be replaced by another inflationary factor.

 

The first question that comes to mind after the revision of the inflation expectation is: If inflation is assumed to be above the current policy rate, will the Central Bank increase the interest rate in the next step? In theory, the next policy step should be in the form of an interest rate hike. Negative real interest rate is a factor of sensitivity in terms of triggering inflation and fragility of capital movements, and the upcoming period may show us that the depreciation of TRY might continue. Mr. Uysal was referring to “reasonable real interest” in his previous speeches, but pointed to expected inflation. It is obvious that the expected inflation direction does not give the desired result at this stage. The important thing is whether the Central Bank will continue to lead the same in this regard. The expectation for 2020 is above the policy rate with 8.9%, but the expectation for 2021 is below the policy rate with 6.2%, although it is revised upwards. If we consider the midpoint of this as a 12-month expectation, the Central Bank will continue to strive to keep the interest at the lowest level it can hold. But how long?

 

In 2020, the Central Bank may seek to normalize the effects of monetary easing by using lateral policy instruments. After that? The picture is uncertain; Within the framework of credit expansion, TRY depreciation and the stickiness effect in inflation, we think that the risks regarding current estimations are also upward. Somewhere in the 2021 monetary policy, the Central Bank may need to consider increasing interest rates.


Hibya Haber Ajansı