Signal of quite gradual normalization from the CBRT

27.07.2023

In its Inflation Report announced today, the CBRT raised its year-end inflation expectation from 22.3% to 58.0%, and its end-2024 inflation expectation from 8.8% to 33.0%. The revised expectations of the CBRT remained well above the 43.8% recorded in the latest Market Participants Survey. In addition, the CBRT stated in its forecast chart published in the report that the upward trend in inflation will continue, and that the peak will be seen in the second quarter of 2024 at above 60%. 10.9 pps of the CBRT's revision for 2023 stemmed from the deviation of the Bank’s forecasts from realization and the change in the forecasting approach, 8.5 pps from food price assumptions, 7.5 pps from the higher-than-expected TL import prices, 7.5 pps from the administrative price hikes and unit labor costs, and 1.3 pps from the revision in output gap estimates. In addition, the CBRT stated that the 34% minimum wage hike in July 2023 is expected to contribute 2.7-4.1 points to inflation.

 The new CBRT Governor Hafize Gaye Erkan, who met with the sector for the first time with a press conference at today's meeting, stated that inflation will be resolved gradually with a holistic approach and that although we will see a pick up in the short term, a retreat will be in the making in the second half of 2024. This statement hints that the CBRT’s independency has not been fully secured considering the upcoming local elections but we should admit that the policy rate’s efficiency has been quite deteriorated by this weird set of policies preventing banking sector’s functioning normally. Referring to the questions regarding the lower than expected policy rate hikes, she stated that more than 100 macroprudential regulations implemented before her term have changed the operating dynamics of the banking sector, and that simplification is a complete optimization problem where the starting point to solve should be the most binding constraint. Stating that other issues will be solved more easily when the most binding constraint is resolved, while Erkan added that this constraint is determined as deposits, hence regulations began with deposits. She stated that their second observation was the effects of credit expansion on inflation, and therefore, the first coefficient (1.4x) in the reference interest rate used in determining commercial loan rates was removed, and the maximum interest rates on credit cards were brought to very high levels. In addition, the excess liquidity is sterilized through required reserves, TL450-TL500bn liquidity is expected to be withdrawn from the market.

Regarding the confusion in the market about whether the implemented policies are targeting inflation or current account deficit, CBRT Governor Erkan stated that the first aim is price stability, while the secondary impact of the actions taken for price stability will contribute to the reduction in the current account deficit. In response to a question about the decline in deposit interest, which is perceived as contrary to price stability, Governor Erkan stated that the deposit rates should be checked at after the withdrawal of TL liquidity and that they expect them to be in line with inflation expectations in the forthcoming period.

Regarding KKM, the President previously announced that the duration of KKM has been extended until the end of 2023, but the CBRT supports diversity in TL-based instruments. She also talked about a TL savings instrument that they have started to work on and that they will announce after a while. Based on these explanations, we may see that the duration of the KKM has been extended or it has been revised and kept in the system. Regarding the transfer of the liability of the Treasury to the CBRT for the payment of exchange rate gains to the depositors, the Governor stated that the exchange rate differences on the KKM should be paid by the CBRT for the sake of predictability in the budget. On the other hand, Governor Erkan did not give any information about whether the KKM burden, which we could follow from the budget details, would be announced by the CBRT regularly after from now on.

The CBRT welcomes the increase in reserves while CBRT Governor in response to a question asked stated that the protocol between the Treasury and the CBRT, which enables the CBRT to intervene in the market through public banks, was not used right now. On the other hand, she stated that the CBRT also has responsibility for the exchange rate stability and said that in case of foreign exchange demand in KKM returns, the CBRT will be providing FX to banks through direct sales.

The main point we understand from the Inflation Report presentation and the speeches of the Governor is that we will see that the regulations for simplification in macroprudential policies and the increases in policy rates will continue but in a quite gradual manner in the upcoming period. Considering the inflation path expected by the CBRT, it is understood that the increase in the policy rate will not be sufficient to curb demand. The statement that gradual and stable interest rate increases will be supported by quantitative and selective credit tightening, and that policies will be advanced as the results of the impact analyzes come out, shows that the priority is given to the banking sector's recovery of the real sector funding function. Based on the statements, we do not expect monthly policy rate hikes to be higher than the one made in the last meeting in the coming months. This would lead to no more than 30% policy rate by the end of the year. This would give some time to the government to prepare for the local elections but erosion in purchasing power will have several side reverberations in the meantime. Providing further support for the affected part of the society might alleviate the impact of harsh price increases but produce several other side effects like wider budget deficit, higher borrowing need and higher bond yields by the half of next year when the pivot in inflation dynamics was expected.