Central Bank’s Revised Inflation Forecast: 58% Year-End Projection for 2023
Esteemed members of the press and distinguished participants, welcome to the Third Inflation Report Briefing Meeting of 2023. I greet you and all viewers respectfully.
Before starting my presentation, I want to emphasize that the primary objective of the Central Bank is price stability.
We have initiated a monetary tightening process to permanently reduce inflation. We will gradually strengthen monetary tightening as needed and when necessary until a significant improvement in the inflation outlook is achieved.
We are closely monitoring inflation and indicators related to the underlying trend of inflation. We will resolutely continue to use all our tools in line with our primary objective of price stability.
In this context, in addition to interest rate hikes, we have taken and will continue to take selective credit and quantitative tightening decisions to support the monetary tightening process.
Therefore, my speech and the subsequent Q&A session will focus solely on inflation and monetary policy.
We are in a transition period before the disinflation and stability periods we anticipate. During the transition, markets are balancing within their internal dynamics.
As a result of the correction observed in the exchange rate and measures towards fiscal discipline, inflation will show a temporary increase in the short term.
On the other hand, in this process, we are carefully laying the groundwork to ensure that disinflation begins sustainably in 2024.
We will begin to feel some of the cumulative positive effects of our interest rate hike decisions and quantitative and selective credit tightening decisions at the end of 2023 and especially in the underlying trend of inflation in the second quarter of 2024.
When the disinflation process begins, temporary corrections in relative prices will give way to exchange rate stability, an improved current account balance, fiscal discipline, a permanent strengthening in capital flows, and increasing reserves.
As a result of these developments, the underlying trend of inflation and expectations will begin to improve consistently.
We see the period after 2025 as the beginning of the stability period. In this period, the decline in inflation will accelerate, while predictability will increase.
Permanently declining inflation will be accompanied by investments and qualified growth.
In my speech, I will first share our assessment of the global economy and inflation in light of the data released since the previous Inflation Report. Then, I would like to present our monetary policy strategy and medium-term inflation forecasts.
Global growth continues to be weak. The global growth index, created using the growth rates and export shares of 110 countries to which Turkey exports, has not shown a significant change compared to the previous Report period. Compared to 2022, external demand is slowing down on an annual basis.
In the Euro Zone, one of Turkey’s major trading partners, the flash manufacturing PMI indicator fell to 42.7 in July, the lowest level since the pandemic.
China, on the other hand, grew by 0.8 percent in the second quarter of the year. This growth remained below expectations and indicated a significant slowdown compared to the first quarter.
With the contribution of the slowdown in global growth, the positive outlook in commodity prices and supply conditions continues in this Report period as well.
The main commodity index has decreased by 18.3 percent compared to the previous year, but is still above long-term averages.
On the other hand, global economic activity is diverging between sectors.
While industrial production is weak, the service sector, which reflects demand conditions more, is maintaining its strength.
The global services PMI index increased in the second quarter of the year, reaching 54.9 and continuing its course above the threshold value.
On the other hand, the manufacturing PMI indicator remained below the threshold value at 49.3.
The divergence between the manufacturing and service sectors is much more pronounced in developed countries.
The decline in growth rates and weakness in industrial production positively affect inflation through the commodity prices channel.
Average consumer inflation in developed and developing countries has decreased to 4.2 percent and 5.1 percent, respectively. Despite this decrease, inflation is significantly above the target values of 2 percent in developed countries and an average of 3.5 percent in developing countries.
Due to the tightness in global labor markets and the dynamism in domestic demand, the stickiness observed in service inflation limits the decline in core inflation and expectations.
Core inflation slightly decreased in the Report period, reaching 4.8 percent in developed countries and 5.6 percent in developing countries.
As a result of high inflation and especially core indicators, central banks continue monetary tightening.
Inflation after the pandemic started at roughly the same time across countries.
However, it is observed that developing countries started interest rate hikes earlier than developed countries and have been more successful in reducing core inflation.
Dear Participants, after mentioning global inflation and monetary policies, I would now like to share our assessments regarding inflation in our country.
Inflation in our country decreased from the peak of 85.5 percent in October to 38.2 percent as of June.
The stability in the exchange rate and the beginning of the decline in global commodity prices were effective in this development.
When we look at the contributions of sub-groups to the June annual inflation, the biggest contribution to the decrease in inflation came from basic goods, food, and especially energy items, which were positively affected by global commodity prices.
On the other hand, the contribution of the services group, which reflects the inertia in inflation, is hovering around 15 points.
We routinely monitor a series of indicators regarding the underlying trend of inflation. In our Bank, both approaches based on the “exclusion method” such as B and C indices and “statistical methods” such as SATRIM and Median inflation are used in determining the underlying trend of inflation.
In order to better understand recent dynamics, we examine monthly or 3-monthly seasonally adjusted inflation data.
The broad set of indicators we follow pointed to a strengthening in the underlying trend of inflation in June.
In this development, the strong course in domestic demand, wage and exchange rate developments, and the stickiness in service inflation are decisive.
Data for the second quarter of the year show that domestic demand, in particular, was effective in the strong course of economic activity.
Retail sales volume index, expenditures made with domestic cards, and turnover indices indicate an acceleration in consumption.
Consumers’ plans to make durable goods expenditures increased rapidly in the second quarter. Automobile and white goods sales are well above past period averages.
Despite the outlook I summarized regarding the course of domestic demand, total supply is progressing more moderately.
The annual increase in industrial production and exports has been slowing down since the second half of 2022, along with external demand.
Although the production loss caused by the earthquake disaster we experienced in the first quarter was compensated in the second quarter, the annual growth rates of these indicators are close to zero.
The decrease in capacity utilization rates in the second half of last year continued in the first quarter due to the disaster. Capacity utilization rates in July are still below the previous year’s level.
The outlook regarding domestic demand and production indicates that total demand conditions are at an inflationary level.
The average of the output gap indicators we follow increased to 2.3 percent as of the second quarter of 2023, after exhibiting a weakening trend in the second half of 2022.
The fact that demand grows faster than supply for a long time poses a significant risk on inflation.
The harmonious movement of supply and demand is important for price stability, and price stability is important for sustainable growth.
Therefore, we anticipate that our selective credit tightening decisions will balance domestic demand.
Closing the output gap will be an important component of the disinflation process.
As a result of the rapid growth of domestic demand, our imports in the first six months of 2023 reached 185 billion dollars, increasing by more than 4 percent, despite the 12 billion dollar reducing effect of energy prices.
Due to global developments, credit expansion, and uncertainty perception, gold imports increased by approximately 11 billion dollars in the first half compared to the same period of the previous year and exceeded 3 times the previous year’s level.
Depending on the acceleration in domestic demand, consumer goods imports increased by more than 8 billion dollars, reaching 1.6 times the previous year’s amount.
As a result of the developments I have stated, our 12-month cumulative current account deficit as of May is 60 billion dollars.
In the second half of the year, we anticipate a significant improvement in the current account balance through the effects of monetary tightening and the service revenues channel.
Strong domestic demand affects both directly and indirectly inflation and exchange rates through the current balance channel. The reflection of exchange rate developments on inflation takes place through different channels such as cost, balance sheet, and expectations.
When we focus on the cost channel, the exchange rate pass-through coefficient estimate, which decreased until 2018, has started to increase again in the recent period.
The findings of the Phillips Curve model, which separates expectation and cost channels and whose parameters change over time, imply that the pass-through may be around 25 percent in the current situation.
Although exchange rate pass-through varies across sectors, the increase in exchange rate pass-through is valid for all sectors.
This is an average effect, and the pass-through may vary depending on the state of the economy. Pass-through occurs quickly, especially in periods when demand conditions are strong.
The monetary tightening process, which we have strengthened with interest rate hikes, quantitative tightening, and selective credit tightening, will support exchange rate stability. Wage increases lead to cost increases, especially in labor-intensive sectors.
Our analyses indicate that the sectors most sensitive to the minimum wage increase are administrative-support services, restaurants-hotels, wholesale-retail trade sectors.
According to our calculations, most of the wage increases will have been largely reflected in prices in the next few months.
This situation is reflected in the forecast path I will present in the following minutes.
Price increases in the service sector continue at high levels, and service inflation exhibits stickiness compared to goods inflation.
While the annual increase rate of the B index, which includes both services and core goods, decreased from its peak of 77 percent to 46.6 percent, service inflation has become sticky above 55 percent.
The diffusion index, which shows the weight of items whose prices have increased compared to those that have decreased, exceeds the historical average when calculated for the service sector. Price increases are spreading throughout the sector.
Time-dependent pricing behavior is more common in the service sector. Service items, according to their pricing behaviors, cause inflationary effects to spread over a long period of time.
We see that items whose prices change at certain times of the year, such as education and health services and rent, exhibit more inertia. The inertia coefficient, which is 0.6 for core goods, is over 0.9 for education and rent.
In addition to rising housing prices and past inflation indexation behavior, supply-demand imbalances in the real estate market are effective on inflation by pushing up rent increases.
Monthly increases in the restaurant and hotel sub-group, which is significantly affected by food, wage, and tourism-related developments, show continuity.
In parallel with these developments in the service sector, inflation expectations have also been exhibiting stickiness at high levels for some time and are rising again in recent months.
Breaking the inertia of inflation depends on anchoring expectations.
In the transition period to disinflation, we expect monetary tightening to provide predictability and balance demand with its cumulative effects. The disinflation period will accelerate with the re-anchoring of inflation expectations.
Monetary Policy
Distinguished Guests,
The target of our monetary policy is price stability. Price stability aims to reduce volatility while inflation decreases permanently.
Price stability is indispensable for macro-financial stability.
For this purpose, we initiated a strong monetary tightening process in June. We emphasized that this process will be gradual, balanced, and stable.
By strengthening interest rate hikes with quantitative and selective credit tightening, we aim to reduce the underlying trend of inflation and anchor expectations. We will resolutely continue to use all our tools until inflation falls back to single digits and our medium-term target.
Before the June MPC meeting, we identified two important headings regarding strengthening the effectiveness of monetary policy.
The first is to reduce the difference between market interest rates and the policy rate. Before our first MPC decision in June, while the policy rate was 8.5 percent, the average deposit rate had risen above 40 percent.
As part of the June MPC Decision, in addition to the interest rate hike, we took the first step of the simplification process in the macroprudential framework with the securities maintenance practice in deposits.
Immediately after these steps, the deposit rate with maturities up to 3 months decreased by approximately 12 points and came to the level of 30 percent.
The reason we started with deposits is that it is the most binding constraint of the banking sector and negatively affects market functionality and price behaviors. Thus, the simplification process in the macroprudential framework, in addition to the interest rate hike, has increased the effectiveness of the policy rate in a balanced way.
Our second observation is to control the inflationary effects of the acceleration in individual loans.
In the first six months of 2023, individual loans increased by over 70 percent in credit cards and over 68 percent in vehicle loans.
Individual loans increased by 40 percent in total. It has exceeded 2 trillion Turkish liras. The first and second quarter growths of this year are more than 3 times the average of the last ten years.
Credit expansion fuels domestic demand, disrupts expectations, and increases imports and the current account deficit.
At the July MPC meeting, in addition to the interest rate hike, we are controlling the effects of credit expansion on inflation with our selective credit tightening decisions within the scope of monetary tightening.
In addition to loans, we are sterilizing liquidity by quantitative tightening, thus strengthening the effect of interest rate hikes.
In summary, in our monetary tightening process, we are making gradual and stable interest rate hikes more holistic and stronger with quantitative and selective credit tightening.
With the decisions we took at the June and July MPC meetings, we increased the policy rate from 8.5 percent to 17.5 percent, a total of 900 basis points. Thus, the policy rate has more than doubled in two months.
With our simplification decision in the securities application, while our policy rate increased, deposit rates decreased. Deposit rates have reached levels more consistent with inflation expectations.
However, we also consider it important that deposit rates are at a level that will not increase dollarization.
For this reason, we decided to make quantitative tightening, taking into account the balance of Turkish lira liquidity.
Thus, the excess liquidity accumulated in the system will be sterilized through required reserves. According to impact analyzes, with the change, between 450 billion TL and 500 billion TL of liquidity will be withdrawn from the system.
We aim to prevent financial resources from being directed to consumption instead of supply and disrupting price stability with selective credit tightening.
In this direction, we reduced the growth limit of 3 percent in vehicle loans to 2 percent.
We reduced the growth limit of 3 percent in other commercial loans, excluding investment, export, agriculture, and tradesmen categories, to 2.5 percent.
We are also supporting the balancing of domestic demand by increasing the monthly maximum interest rates applied to credit card cash withdrawals and credit deposit accounts.
When we come to interest rate practices, the first tranche has been removed in Turkish lira commercial loans, excluding export and investment loans. The application of the interest rate limit as a single tranche in firm loans will provide an additional contribution to the supply/demand balance.
I would like to state that we use all our tools with a holistic understanding and by carefully analyzing and optimizing the possible effects of our decisions. With the same understanding, we will continue to take gradual and decisive steps.
Central Bank international reserves have shown a strong increase since June.
Gross international reserves decreased from 128.8 billion dollars as of the end of 2022 to 98.5 billion dollars at the end of May.
Our reserves have increased by approximately 15 billion dollars as of July 14 and have risen above 113 billion dollars.
When we look at the risk premium, there is a positive outlook. The 5-year CDS premium reached the peak level of this year by exceeding 700 basis points in May due to the effect of domestic uncertainties.
A significant downward trend started in June and has decreased to the level of 435 points as of today.
Along with the decrease in risk premiums, a net portfolio inflow exceeding 1.5 billion dollars has been realized since June.
We also see that exchange rate volatilities in the market have decreased.
The exchange rate volatility implied by 1-month USD/Turkish lira options rapidly decreased from the peak level of 57 points in May to the level of 20.2 points as of July 25.
Similarly, the exchange rate volatility implied by 12-month options, which saw the level of 47 points in May, fell below 30 points on July 25.
We are seeing the positive effects of our monetary policy strategy on the markets. Our reserves are strengthening, financing conditions are improving, and implied exchange rate volatility is decreasing.
Medium-Term Forecasts
Dear Participants,
After the economic outlook I have summarized so far and which reveals the starting point of our forecasts, I will now share our medium-term forecasts with you.
We have updated our assumptions regarding the Global Growth Index, which summarizes external demand, slightly upwards for 2023 and downwards for 2024.
Since the previous Inflation Report, crude oil prices in spot and futures markets have realized in line with our forecasts.
Our assumptions regarding oil prices have remained flat.
Due to geopolitical and supply-oriented effects reflected in futures markets in commodities and energy, we have updated our import price assumptions for 2024 upwards.
The upward trend in domestic food prices, on the other hand, continues due to supply-oriented problems and inadequacies in market structure.
Significant increases have been observed recently in red meat and processed food products related to red meat.
In addition to red meat, we have also observed high rates of increase in vegetable prices affected by supply conditions.
In the coming period, we have reflected the assumption that food price inflation will complete 2023 at the level of 61.5 percent and 2024 at the level of 35.0 percent in our forecasts.
Distinguished Guests,
In this framework, we have made a significant update in our inflation path.
We have increased our year-end inflation forecast for 2023 to 58 percent.
We have updated our year-end forecast for 2024 to 33 percent.
We estimate that inflation will decrease to 15 percent at the end of 2025.
The revision in our forecast path is 35.7 points for the end of 2023 and 24.2 points for the end of 2024.
I would like to share with you the sources of this significant change in our forecasts.
In this context, developments in Turkish lira denominated import prices compared to the previous Report period increased the year-end inflation forecast for 2023 by 7.5 points, while pushing our year-end inflation forecast for 2024 upwards by 8.3 points.
Exchange rate developments have been the main determinant in this development.
Food prices affected our forecasts upwards by 8.5 points for 2023 and 6.0 points for 2024 due to the effect of realization and increase in assumptions.
In addition, changes in other economic policies such as transfers to households, tax, wage, and administered directed price adjustments affected our year-end inflation forecast for 2023 upwards by 7.5 points, while increasing our year-end inflation forecast for 2024 by 3.6 points.
The fact that domestic demand is progressing stronger than our forecast pushed our year-end inflation forecast for 2023 upwards by 1.3 points and our year-end forecast for 2024 by 0.4 points.
Finally; the effect of forecast deviation and change in forecast approach had an increasing effect of 10.9 and 5.9 points on our year-end inflation forecasts for 2023 and 2024, respectively.
The main reason for the upward change we made in the inflation path we presented due to the forecast approach is that the feature of being an intermediate target was emphasized in the path presented in the previous Report, while our current projections were formed within the framework of the Central Bank’s technical forecasts along with the changing macroeconomic outlook.
Our inflation forecasts include our policy responses and their cumulative effects.
We are giving our monetary policy response focused on reducing the underlying trend of inflation. We are closely analyzing the monetary and financial conditions that affect the underlying trend of inflation.
While gradually increasing the policy rate, with the simplification process in the macroprudential framework, we will both increase the functionality of market mechanisms and try to shape market interest rates at a point more consistent with inflation expectations.
In addition, we are taking and will continue to take balancing steps targeting inflation through selective credit tightening.
Together with our quantitative tightening decisions, we will ensure the stable development of Turkish lira liquidity without creating excesses on the exchange rate and domestic demand.
As we have started our work and will announce it after a while, we will diversify Turkish lira savings instruments and support the deepening of capital markets.
The Central Bank will make decisions in accordance with the principles of trust, stability, and transparency, completely based on data and in full coordination.
By continuously measuring the effects of our decisions on inflation, markets, monetary and financial conditions, we will dynamically optimize the monetary tightening process.
Our goal with our gradual and stable progress is to ensure the re-anchoring of expectations, as well as predictability.
As I conclude my speech, I would like to thank once again in your presence all my colleagues who took part in the preparation for the Report process and press conference, especially our Monetary Policy Committee members and Research and Monetary Policy General Directorate employees.
Now we can move on to the Q&A section of our meeting.