Despite the sharp lira weakening and its impact on import prices and its likely impact on expectations, price pressures remained muted, reflecting sharply weaker domestic demand and depressed energy prices in April.
The 0.85%m/m increase in consumer prices was almost equal to our forecast of 0.87% and was somewhat higher than the market consensus of 0.60%. Still, due to a much stronger base, annual inflation fell sharply to 10.9% in April from 11.9% in March. Importantly, the 2.5% increase in food prices and especially the 3.7% jump in unprocessed food prices were the main drivers of inflation while the monthly core inflation of 1.0% stayed significantly below the market consensus of 1.8% in April.
As a result, annual core inflation also fell sharply to 9.9% from 10.5% a month ago. To repeat, this was despite the sharp lira weakening, supporting our view that the FX pass through has been much milder than in the past, mainly due to the negative output gap.
We expect this disinflation trend to persist with weak demand and depressed global commodity prices offsetting the pressure coming from FX weakness in the coming months. Hence, base effects will likely determine the inflation path. We expect annual inflation to fall to single digits in July (Figure 1) and end the year at 8.1%.
Given the weakness in demand, the risks on the forecast are skewed to the downside and a disorderly currency weakness constitutes the main upside risk to the forecast. The CBRT has already cut rates substantially and the current policy rate of 8.75% is way below the annual inflation. However, the CBRT is focused on its inflation forecast rather than ex-post inflation in calculating the real interest rate. Hence, the disinflationary trend should still provide room for the CBRT to cut rates further. Global financial conditions and especially the currency market will likely determine the timing and the magnitude of the cuts.
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