Karahan: The Disinflation Process Continues, and Macroeconomic Indicators Are Advancing Accordingly
Forex - Central Bank President Karahan stated that the disinflation process is ongoing and added, "Macroeconomic indicators are also progressing in line with this process."
Karahan noted that domestic demand has continued to slow down, supporting the reduction in inflation to more manageable levels, and emphasized that, as a result of this slowdown, the decrease in the current account deficit is also ongoing.
Turkey's Central Bank President Fatih Karahan held a presentation meeting for the "Inflation Report 2024-IV."
In his speech, Karahan said: "Our disinflation process is ongoing. Macroeconomic indicators are also progressing in line with this process.
We assess that domestic demand has slowed down, supporting a decrease in inflation to manageable levels. With the impact of this slowdown, the reduction in the current account deficit is continuing.
Although the main trend of inflation is improving more slowly than we anticipated, it is still improving.
We will maintain our tight monetary policy stance in a way that ensures the continuation of disinflation.
In the upcoming parts of my speech, I will provide detailed evaluations regarding all these factors I mentioned.
I will first share our assessments regarding the global economy, macroeconomic outlook, and our monetary policy stance. Afterwards, I will present our medium-term forecasts. Following that, we will answer your questions along with our Deputy Governors.
In this report, we again highlight prominent issues and thematic analyses with box studies.
In the boxes of this report, we will cover our studies on the effects of Fed interest rate cuts, fiscal policy within the framework of the OVP, main inflation trends, consumer expectations, firm meetings, and loans. I would like to draw your attention to these box studies.
I will begin my speech by addressing recent global economic developments.
The outlook for global growth continues to show a gradual recovery, in line with the previous report period. However, we observe that downside risks have increased.
The divergence observed between the manufacturing and services sectors during the previous report period continues.
Leading indicators suggest that downside risks in the manufacturing sector have somewhat increased.
The global demand outlook, geopolitical risks, and supply-side factors continue to be decisive in commodity prices.
Recently, widespread increases have been seen in non-energy commodity prices, while geopolitical developments have particularly heightened volatility in energy prices.
Dependent on the inflation outlook, central banks in developed countries have begun the process of interest rate cuts. The Fed made its first interest rate cut in September.
In emerging economies, we see new central banks joining the previously initiated interest rate cut process.
A moderate growth and inflation outlook on a global scale indicates that central banks may be able to reduce monetary tightness in the upcoming period as well.
On the other hand, the inertia in inflation continues to weaken but remains. Therefore, communication is maintained that necessary monetary tightness will be preserved and that the rate cut processes will be conducted cautiously.
Additionally, we observe that central banks such as Brazil and Russia are increasing policy rates due to country-specific inflation outlooks.
MACROECONOMIC OUTLOOK
Now, I would like to share our findings regarding domestic macroeconomic developments.
In the second quarter of the year, the contribution of domestic demand to annual growth significantly decreased while the positive contribution of net exports to growth continued.
During this period, domestic demand contributed 1.2 points to growth while the contribution from net exports was 1.3 points.
Thus, the demand composition in growth exhibited a more balanced appearance.
Current data for the third quarter indicate that the moderate trend in domestic demand is continuing.
During this period, retail and trade sales volume indices increased somewhat compared to the previous quarter.
However, when we take a closer look at the retail sales volume index, the increase excluding gold is more moderate.
In addition to these indicators, field observations obtained from firm meetings also confirm the slowdown in domestic demand.
Current supply indicators for the third quarter align with the slowdown in domestic demand.
While industrial production decreased during this period, when we exclude highly volatile sectors, the decline in production was more limited.
The services production index has displayed a stronger appearance compared to industrial production, although there was a limited decline in quarter-on-quarter basis with data from July and August.
Overall, the moderate loss of momentum in production indicators in the third quarter aligns with the overview of demand outlined.
In this context, the conditions of demand have approached levels that support the decrease in inflation.
Indicators calculated through different methods show that the output gap narrowed in the third quarter. We assess that this decline will continue into the last quarter of the year.
At this point, I want to emphasize that; as a result of our tight monetary policy, the balancing process in domestic demand will continue. The negative output gap that will occur in the upcoming period will be an important component of the disinflation process.
As domestic demand stabilizes, we see that the improvement in the foreign trade balance continues.
With this reflection, the ratio of the current account deficit to national income fell to 1.7% in the second quarter. We predict that the cumulative current account deficit will continue to decrease in the third quarter.
As we mentioned earlier, during tight monetary policy periods, there is an improvement in the current balance.
In the upcoming period, we expect the positive trend in the current balance to continue in accordance with our tight monetary stance.
In this section of my speech, I would like to share our evaluations regarding inflation.
Consumer inflation fell to 48.6% in October, marking a significant decrease compared to the peak in May.
Global commodity prices, except for October, have continued to trend downward, supporting the disinflation process. The nominal exchange rate has followed a moderate trend after the increase in August.
As I mentioned earlier, demand continues to slow down, supporting a decrease in inflation to manageable levels.
Moreover, the improvement in inflation expectations gradually continues.
As we always emphasize, we closely monitor the main trend of inflation.
We have evaluated our core trend indicators in terms of neutrality, volatility, and forecasting performance. You can review our box study on this subject.
Our analyses show that the performance of indicators varies according to these criteria. This highlights the importance of tracking the main trend of inflation through various indicators.
When we examine the indicators we monitor within the TCMB as a whole, we see that the decrease in the main trend of inflation continued in October.
Core goods inflation maintains its low trend, driving the slowdown of the main trend.
The improvement in service inflation, however, is happening more slowly than we anticipated. Here, a gradual improvement is being observed, particularly in the non-rental segment. In October, we observed a moderate trend in some demand-sensitive service items. We assess that this appearance will continue.
On the other hand, looking at the groups outside of core inflation, we observed a strengthening of energy price increases in the third quarter. In this development, the effects of price developments in administered energy items and fixed tax updates stood out.
Regarding food, the improved outlook in the third quarter was disrupted by unprocessed food prices in October. During this period, we observed high price increases in the fresh fruit and vegetable category, which is relatively outside the influence of monetary policy. On the other hand, food inflation excluding fresh fruit and vegetables remained lower.
Focusing on service inflation, the high trend in the third quarter was led by rent and education, characterized by seasonal pricing and backward indexation behavior.
In the third quarter, the back-to-school effect was prominent on service inflation. Education services rose sharply due to high university fees. School transportation fees increased transportation services, while school dormitory fees pushed accommodation service prices up. With the completion of the back-to-school period, the relative price adjustments in the mentioned groups were largely completed.
We assess that it is more appropriate to analyze service price dynamics in terms of rents and non-rent.
Rents are a structural issue that should be treated separately from other service items due to reasons such as earthquake, urban transformation, and rent increase limitation.
Indeed, the significant price increase in rents continued in the previous quarter, influenced by the rise in the contract renewal rate in the third quarter. As you can follow from the graph on the right, both the rent increase rates obtained from PÖS data and those from housing appraisal reports remained below and have decreased compared to the annual rental inflation of the CPI.
The decrease in the reference rates used in rental contracts indicates that monthly rental inflation will slow down in the last quarter. We recommend you take a look at our box study on this subject.
While we assess that the inertia in rental inflation is higher than we anticipate, we observe that services excluding rent have exhibited a more pronounced slowdown.
Looking at the industrial side, we see a clear improvement in firms' pricing behavior.
In the manufacturing industry, when we examine domestic sales price expectations, the proportion of firms planning to increase prices among those expecting increases in both domestic demand and unit costs is steadily declining.
The proportion of firms planning to increase prices among those not expecting an increase in unit costs is also decreasing.
Indeed, producer monthly inflation has averaged around 1.4% in the last three-month period. Thus, the pressure on consumer inflation from producer prices is weakening.
This trend in producer inflation positively affects commodity prices in the CPI. As can be seen from the left panel, price increases for core goods have significantly weakened. Although there was a partial rise in August due to the depreciation of the Turkish lira, core goods inflation continues to remain low.
In the last three months, the annualized main trend for core goods is around 20%.
Especially, the price trend for durable goods appears to be moderate.
In the course of pricing behavior, the size of price increases is as important as their prevalence.
Demand conditions affect not only the magnitude of price increases but also their spread. Indeed, there is a distinct positive correlation between the output gap and the spread index.
During periods of cooling, when the output gap takes negative values, the spread of consumer price increases also decreases.
Currently, with the normalization of demand conditions, we observe a decline in the spread index.
Analyses indicate that as the output gap continues to decline, the spread of price increases may further lose strength in the upcoming period.
The trajectory of inflation expectations is important regarding the speed of disinflation.
The leftward shift in the distribution of inflation expectations regarding 12 months ahead, from market participants, indicates an improvement in expectations. Moreover, the distribution exhibits a unimodal appearance with increased consensus among expectations. However, the pace of improvement in expectations is not yet at the desired level. It is critical that inflation expectations converge to our forecast range concerning the cost of disinflation.
As you will see from the right panel, there is also a continued improvement in inflation expectations among the real sector and households. We recommend you read our box study regarding consumer inflation expectations.
With the decline in headline inflation, expectations across all sectors are gradually decreasing. We are determined to ensure that expectations form in a way that contributes to the disinflation process with our tight monetary policy stance.
MONETARY POLICY
In this section of my speech, I will provide information about our monetary policy stance.
As you know, we have kept the policy rate constant at 50% for seven months since raising it in March.
Additionally, to enhance the effectiveness of monetary transmission against divergences in economic agents' expectations and potential volatilities, we continue to implement macroprudential policies.
We can summarize the macroprudential measures we use to support our tight monetary stance into three main groups:
The first is regulations regarding deposits. Within this scope, we have measures to increase the share of TL deposits and gradually reduce the KKM. In August and September, we updated these regulations considering the conjunctural developments.
Secondly, we have regulations regarding loans. We imposed monthly growth limits on TL and foreign currency loans to prevent fluctuations in loan demand. To support healthy price formation in the credit market, we have also updated the maximum early repayment fees for commercial loans.
Thirdly, we have steps regarding liquidity management.
We sterilize the excess liquidity that arises seasonally by using required reserves and our existing other instruments.
We also sterilize the excess liquidity through foreign currency and gold swap auctions in addition to Turkish lira deposit purchase auctions.
We closely monitor liquidity conditions, taking potential developments into account. We will continue to use our toolkit effectively.
Looking at financial conditions, composite commercial loan rates are priced at around 56%, consumer loan rates at 66%, and deposit rates at about 59%.
In the deposit rates, in addition to the policy rate, macroprudential policies, and liquidity in the market, inflation and exchange rate expectations are also determining.
Our monetary policy stance and macroprudential framework will ensure that deposit rates remain at levels that support the transition to Turkish lira and savings.
The continued improvement in expectations also aligns loan pricing with our disinflation path.
With the improvement in inflation expectations, we have particularly observed a decrease in long-term TL financing costs.
We expect this trend to continue in the upcoming period as the improvement in expectations persists.
It is crucial that consumer loans proceed at a pace that will establish balance in domestic demand.
In the first quarter of 2024, the acceleration in loan demand resulted in growth in consumer loans driven by credit cards and personal loans.
With our macroprudential measures and tight monetary policy stance, the growth in consumer loans is weakening and moving on a more moderate path.
On the commercial side, Turkish lira loan growth is consistent with monthly growth limits and loan demand.
On the other hand, we reduced the monthly growth limit imposed on foreign currency loans in May.
As a result of these limitations, the growth in foreign currency loans is aligning with targets.
We observe that the interest and confidence in Turkish lira assets have increased due to our steadfast tight monetary stance and the implementation of measures to reduce KKM balances.
The share of Turkish lira deposits has reached 56%. The share of KKM has fallen below 8%.
The total of KKM accounts rose above 140 billion dollars in August 2023. The current balance has decreased to 37 billion dollars.
The transition rates from maturing KKM accounts to TL were around 10% at the beginning of the year, but recently it has exceeded 25%.
The decrease in KKM balances strengthens the monetary transmission mechanism by increasing the share of Turkish lira deposits and reduces risks on the central bank's balance sheet.
We expect the gradual and stable increase in the share of TL deposits to continue to be an important element of our disinflation path.
On the other hand, recently, while capital inflows have slowed down due to decreased risk appetite in global markets, we observe that capital movements towards Turkey have been moderate.
In the upcoming period, capital inflows may exhibit volatility depending on geopolitical developments.
The increase in confidence of domestic and foreign residents in the Turkish lira continues to positively reflect on our reserves.
Since August, we have started reverse swap transactions for sterilization purposes. Between March 22 and November 1, gross reserves increased by 36 billion dollars, while our net foreign currency position, excluding swaps, improved by 110 billion dollars.
As of November 1, our gross reserve level exceeded 159 billion dollars. Our net reserves, including Turkish lira equivalent foreign currency swaps, rose to 46 billion dollars.
Our tight monetary policy stance supports the improvement in risk perception towards Turkey and the decrease in risk premiums.
As a result of the trust in the policies we implement, the level and composition of reserves have significantly improved.
Although the risk premium has exhibited a volatile appearance due to geopolitical developments, it has maintained a moderate trend.
Additionally, during this process, upgrades in credit ratings from agencies supported the external financing outlook.
MEDIUM-TERM FORECASTS
After summarizing the economic outlook that forms the backdrop to our forecasts, I will share our medium-term forecasts with you.
We have maintained our assumptions regarding external demand.
We have revised our crude oil price assumption downward for 2024 and 2025 based on actual occurrences.
However, we updated our food price assumption upward due to unprocessed food inflation.
In forming our medium-term forecasts, we have based our approach on continuing the tight monetary policy stance until a significant and permanent improvement is achieved in the inflation outlook. Furthermore, we have reflected that coordination in economic policies will also continue to increase in our forecasts.
In this context, we have upwardly revised our end-2024 and end-2025 inflation forecasts to 44% and 21%, respectively.
We anticipate that inflation will decline to 12% by the end of 2026. In the medium term, we aim for inflation to stabilize at 5%.
The lower and upper points of the forecast ranges correspond to 42% and 46% for 2024, 16% and 26% for 2025, and 6% and 18% for 2026.
Recently high food prices have had a 1.6 point impact on our end-2024 forecast update.
The total impact of the Turkish lira-denominated import prices and demand conditions on our forecast update was half a point.
The slower-than-expected improvement in expectations increased our end-2024 forecast by 3.9 points due to starting conditions and the main trend of inflation.
In our end-2025 forecast update, we estimate the total impact of food prices, Turkish lira-denominated import prices, and our guided price assumptions to be 3.3 points.
Moreover, the update in our 2024 forecast increased our end-2025 forecast by 3.5 points through inflation inertia and the main trend.
Lastly, the update on the output gap path had an impact of 0.2 points on our end-2025 forecast.
Our consistent stance in monetary policy will continue to lower the main trend of monthly inflation through domestic demand balancing, real appreciation of the Turkish lira, and improvement in inflation expectations.
We foresee that with the continuation of our cautious stance in monetary policy, annual inflation will steadily decline in the upcoming period. During this process, the alignment of demand conditions with financial conditions will continue to support the decrease in inflation.
With a weakening of the rigidity in service inflation, the decline in the main trend of inflation will continue in 2025. The increasing coordination between monetary and fiscal policies will also contribute to this process.
We will resolutely maintain our tight stance until price stability is achieved.
As we previously emphasized, we are considering two main conditions during this process:
The first is a significant and permanent decrease in the main trend of monthly inflation. In this context, we closely monitor indicators related to the main trend, domestic demand, imports, and financial conditions.
The second is that inflation expectations converge to the projected forecast range. Within this framework, we track comprehensive indicators of inflation expectations.
Once again, I want to emphasize that price stability is a prerequisite for sustainable growth and increased social welfare.
During the disinflation process, we will continue to do whatever it takes to reduce inflation in line with the intermediate targets we have set.
In concluding my speech, I would like to express my gratitude to all my colleagues who contributed to the preparation of the report process and the press conference, particularly our Monetary Policy Committee members, Advisors, and employees of the Research and Monetary Policy General Directorate.