Turkey's inflation surges to 75% as government shifts policy

In May, inflation in Turkey accelerated from 69.8% to 75.45% year over year, reaching its highest level since November 2022. Forecasts had anticipated a reading of 74.8% y/y. The main cause of the increase is the effects of the statistical base and the removal of subsidies for gas bills, comments Bartosz Sawicki.

Inflation in Turkey reached 75.45% in May, higher than the expected 74.8%. As analyst Bartosz Sawicki noted, the index reached its highest level since November 2022.

The direct causes of the CPI spike are the statistical base effects and the removal of subsidies for gas bills. However, Turkey's inflation problems actually stem from years of maintaining an extremely loose monetary policy and fiscal recklessness, which led to an overheating economy and the collapse of the lira, writes the commentary's author.

"President Recep Erdogan only allowed a 180-degree policy shift after securing re-election in May 2023 and turned to a more conventional approach. Since then, interest rates have been raised from 8.5% to 50%. The monetary authorities believe that the March resumption of the rate hike cycle and the increase in the cost of money by 5 percentage points will suffice to control inflation," indicates the analyst.

As he notes, Turkish authorities believe that the radical tightening of policy is beginning to yield results. Slowing momentum of price pressure is seen as a good omen.

In May, the CPI dynamics fell below 3.5% for the third consecutive month. From June on, year-over-year inflation will start to plummet due to statistical effects. As a result, no further rate hikes are expected, the next change should be a rate cut. The timing of easing remains debatable - states Bartosz Sawicki.

Years of forcing an extremely loose policy by the ruling camp and negative real rates have led to the build-up of dangerous macroeconomic imbalances and the collapse of the lira, which depreciated by approximately 40% in the past twelve months. In an overheating economy, the problem of inflation returns like a boomerang. In this light, the central bank's projections appear overly optimistic - reads the commentary.

Official forecasts suggest a drop in inflation to 38% y/y by the end of the year. The market consensus assumes that in the fourth quarter, the rate of price growth will remain above 40%.

The pace of disinflation will not only determine whether rates in Turkey will be cut at the end of the year - notes the analyst.

"This is the key to improving investor sentiment, intensifying capital inflows affecting the pace of foreign exchange reserve recovery and, consequently, the condition of the lira. The March policy tightening through rate hikes and the use of several additional tools reducing liquidity in the financial system has allowed for stabilising the Turkish currency at a historical low," he writes.

The USD/TRY rate still exceeds £25, Cinkciarz.pl sees the lira risk gradually losing another 8% in the second half of 2024.