Turkey: Headline CPI surprises to the upside; core remains more benign

For the second time in a row, headline surprised to the upside and core surprised to the down side. Headline CPI was up 1.1% vs 0.7% expected while core prices were up 0.4% vs 0.6% expected in August. Annual inflation thus rose to 19.3% from 19.0% in headline and fell to 16.8% from 17.0% in core. The upside surprise in headline came from the 3.2% jump in food prices. In particular, the 10.1%m/m increase in fruit and vegetable prices was unprecedented in a summer month and most probably reflected the drought and the wildfires. Although the underlying price pressures seem to have waned marginally (in 3m/3m saar terms, core inflation fell to 13.2% in August from 14.1% in July), the upside surprise still encouraged us to automatically revise our end-2021 inflation forecast up to 15.5% from 15.0%. We expect annual inflation to remain roughly stable in September and fall more slowly in October and faster in November and December (Figure 1). The recent lira strength and some moderation in domestic demand will likely reduce the upside pressures on inflation. Indeed, sequential data show some weakening in the underlying inflationary pressures. In 3m/3m saar terms, core inflation came down to 13% from 23% in the last five months (Figure 2). The strong base in will be the main reason behind the expected fall in inflation in the last two months of the year.

However, domestic demand is still relatively robust and this is reflected in the ongoing increases in consumer durable prices (white goods prices rose by 2-3%m/m in July). There was a decline in automobile prices but this mainly reflected the impact of the tax cut introduced by the government. The lagged impact of lira weakness along with elevated global commodity prices has been leading to sharp increases in import prices. Furthermore, pandemic-related restrictions have been causing supply constraints and aggravating the cost-led price pressures. This is vividly seen in the PPI data. Annual PPI inflation reached 45.5%. Importantly, the difference between PPI and CPI inflation is at its highest point in recent history. Finally, inflation expectations continue worsening. The market consensus on 12-month ahead inflation was already up two percentage points over the last six months. We fear that this worsening gets more traction after the upside surprise in August. This credibility gap could easily mitigate the disinflationary impact of high interest rates and slow loan growth and hence hurt policy effectiveness.

In this environment, it is extremely important that the CBRT restores some credibility and refrains from delivering any premature easing. The CBRT has been vocal on the need for tight policies and the strong economic activity data along with the progress in the fight against the pandemic could reduce the risk of premature easing, in our view. The strong Q2 GDP data released earlier this week and the consistent strength in high frequency activity data should make politicians happy and hence provide breathing room for policy makers. We still see two 50bp cuts in the last two months of the year. We see the policy rate at 15.0% at the end of 2022, but as always, a series of factors – macroeconomic and political in nature – create significant uncertainties. The CBRT had stated in the last investor seminar that it would focus on core. So, we do not think the CBRT itself will be overly worried by the August figures.

  Source: JP Morgan