If the Central Bank intervenes to lower lira’s value as was done in the late 2010 and early 2011, inflation will increase.

The same old scene has been playing in consumer price index (CPI) and headline inflation for some time now. In spite of temporary ups and downs in the indices, trends vanish when you extent the analysis over a longer timeframe. Rather they are replaced by floating movements around an average value. Figures for February demonstrate a similar tendency: year-end CPI inflation had a value of 7 percent, higher than December’s 6.2 percent and lower than January’s 7.3 percent. The average that CPI inflation figures have been floating around since 2009 is 7.5 percent.

5.4 percent average

The l index which does not cover energy, food, non-alcoholic beverages, alcoholic beverages and tobacco products had a value of 5.8 percent in February. The index has been at this level (or slightly lower at 5.7 percent) for the last four months. The average headline inflation since 2009 is 5.4 percent. That is, headline inflation in the last month was slightly above the average (Figure 1).

There are various factors that affect inflation. One among these, crude oil prices have been higher compared to December, while there is no evident upward trend. In the first months of the year domestic demand might have recovered to some degree. Despite the efforts to limit domestic credit growth, low interest rates have been pushing up the consumption of moderate-price goods that do not rely on consumer loans as well as that of consumers who are not in need of loans to raise consumption. These two factors might put a limited pressure up on inflation. At least, the recent chances in these two factors will not put a downwards pressure on inflation.

Therefore, exchange rate movements will be the main determinant of the inflationary outlook.  Given the current international developments, risk appetite towards countries like Turkey is quite high. The most reasonable prospect would hence be continuing short-term capital inflows and a downward pressure on exchange rates. The Central Bank has been stressing that it will prevent any appreciation of lira in real terms. Indeed, it has introduced a series of decisions in this direction. If the Bank does not make any intervention other than preventing lira’s appreciation, headline inflation will float around 6 to 7 percent. If it intervenes to lower lira’s value as was done in the late 2010 and early 2011, however, inflation will increase. I believe that the Bank has been pursuing the first option.

Figure 1. Change in headline inflation (l index), January 2009 – February 2013 (%, annual)

Source: TURKSTAT

This commentary was published in Radikal daily on 05.03.2013