SUMMARY OF THE MONETARY POLICY COMMITTEE MEETING
Central bank: tcmb | Type: decision | Date: 2007-09-13

No: 2007-25
19 September 2007
SUMMARY OF THE MONETARY POLICY COMMITTEE MEETING
Meeting Date: September 13, 2007
Inflation Developments
1. Consumer prices rose by 0.02 percent in August, bringi ng annual inflation to
7.39 percent. As predicted in the summary of the previou s Monetary Policy
Committee (the Committee) meeting, the rise in annua l inflation rate was due
to price increases in the unprocessed food group. Favorable developments in
the prices of other goods and services suggest that this recen t increase in
annual inflation rate would be temporary.
2. Volatility in the unprocessed food prices, which has be en experienced since
early 2007, also continued in August. According to seasona lly adjusted
figures, there was a notable rise in the prices of the u nprocessed food group
last month, due to price hikes primarily in fresh vegetab les and also to a
lesser extent in unprocessed food products other than fresh vegetables and
fruits. Annual inflation rate in the processed food group, on the other hand, fell
in August thanks to last year’s base effect.
3. Favorable developments in the prices of the energy sect or have continued in
August. Prices of energy items for housing group displayed a limited increase,
while domestic fuel prices dropped following the decline in crude oil prices in
international markets. Overall, price developments in the energy group, with a
2.56 percent year-to-date inflation rate, have support ed the disinflation
4. Strong monetary tightening continues to be effective on prices of consumer
durables. In line with the slowdown in demand, the pr ices of consumer
durables group have declined in the last five months and this trend has
spread across the group. As of August, the annual inflati on rate in this group
came down to – 2.80 percent.
5. The Committee noted that the recent developments in services inflation have
been more favorable than expected. The downward trend that has been
observed in the services inflation since the beginning of 2 007 has became
more significant in August. Annual inflation in all ser vices items has come
down, with rents being the most remarkable. Following the benign course of
fuel prices, annual services inflation in the transportati on group declined in
August. Recent rate cuts in local phone calls affected tele communication
group, as expected.
6. The impact of monetary tightening on disinflation was also evident in core CPI
measures. The annual rate of increase in the widely cite d core indicator-H
(CPI excluding food, energy, alcohol-tobacco and gold), which has been
declining since April, continued to fall in August. Seaso nally adjusted monthly
changes in this index have also indicated a downward trend in inflation.
7. In light of these assessments the Committee concluded th at the improvement
in services inflation was beyond expectations, while develop ments in other
price categories were in line with the outlook presented in the July Inflation
Factors Affecting Inflation
8. Gross Domestic Product increased by 3.9 percent in the se cond quarter of
2007 compared to the same quarter of the previous year. In that period the
contribution of net external demand decreased but remai ned positive,
whereas the contribution of domestic demand increased mod erately. Of the
domestic demand components, private consumption expenditure s declined in
annual terms as projected in the July Inflation Report. This can be attributed
to the lagged effects of monetary tightening on the d emand for consumer
durables. Meanwhile, investment expenditures accelerated i n the same
period and became the main determinant of the growth in domestic demand.
9. The analysis of seasonally adjusted expenditures showed that the key
developments in the second quarter were the increases in p ublic investment
expenditures and private sector machinery-equipment investm ents. The
contribution of public expenditures to the GDP was almost half of the overall
growth rate. As stipulated in the Summary of the Mone tary Policy Committee
Meeting in August, private consumption demand followed a trend similar to
the one observed in the first quarter and increased mode stly compared to the
previous quarter. Against this background, the moderate g rowth in the
domestic demand has continued.
10. Leading indicators for the third quarter point to a recovery in private
consumption demand. According to seasonally adjusted figur es, domestic
sales of automobiles in the July-August period, domestic sa les of white
goods, and imports of consumer goods in July increased signi ficantly
compared to the previous quarter. The Committee noted that despite recent
upsurge, sales figures remained well below the levels seen in the first half of
2006. On the other hand, the July-August average of th e CNBC-e
consumption index was well above its second-quarter level, w hile consumer
confidence indices confirmed the recovery in private consumpt ion demand.
The pace of consumer loans in recent months also revealed a similar outlook.
11. The recovery in investment demand, which has started i n the second quarter,
has continued in the third quarter as well. Imports of capital goods picked up
in July and commercial vehicle sales in the July-August peri od increased
noticeably compared to the same period last year. Season ally adjusted
figures were also significantly above their second quarter levels. Other
indicators for investment demand, such as imports of machine ry-equipment
and electrical machinery, also indicated an upward trend in the third quarter.
All in all, initial readings in the third quarter po inted out acceleration in
investment demand, particularly in investment good imports.
12. There was a noticeable increase in public expenditure s in the second quarter,
which contributed as many as 1.8 percentage points—almost h alf of the total
value added—to annual GDP growth and slowed down the d isinflation
process. While forming the inflation outlook, the Commi ttee projected that, in
line with budget targets for 2007, there would be a significant decline in the
contribution of public expenditures to growth in the seco nd half of the year,
and that would restrain the growth in total domestic demand.
13. Despite the strong course of external demand, the ra te of increase in imports
exceeded the growth rate of exports in June and July, fol lowing the recovery
in domestic demand. While the robust course of exports is e xpected to
continue for the rest of the year, there may be a slow down in annual growth
rates due to loss of working days caused by religious holid ays and the last
year’s high base effect. As the growth of imports outpace that of exports, net
exports are expected to have a negative effect on GDP grow th in the second
half of the year.
14. Since mid-2006 strong monetary tightening has rest rained the growth rate in
employment, particularly in services sector. The downward trend in non-
agricultural unemployment rate has ceased in recent peri ods, easing the
pressure on wages. It is believed that this outlook will b e maintained provided
that the incomes policy is conducted in harmony with the inflation target.
Meanwhile, ongoing productivity gains in the manufactur ing industry is
another factor that restrains unit labor costs.
15. In sum, it is projected that the recovery in private investment and
consumption demand will continue without a significant a cceleration, the
contribution of external demand and public expenditures to growth will
decrease and thus, aggregate demand and capacity conditio ns will continue
to support the disinflation process.
Monetary Policy and Risks
16. Since the impact of monetary policy on economic activi ty and inflation is
observed with a lag, the Committee takes the monetary p olicy decisions on a
medium term perspective. In this respect, it is particularl y important to identify
the short term temporary movements from medium term tr ends. Recent
readings reveal important information on the medium term inflation trends:
17. Although the headline CPI inflation was up in Au gust, several sub-items of the
index indicated significant favorable developments. The de celeration in
services inflation is promising for the medium term infla tion trend. Moreover,
seasonally adjusted figures of the core indices suggest that the underlying
inflation is moving towards the medium term targets.
18. Recently announced GDP figures confirmed that the d omestic demand has
continued to slow down in the second quarter of 2007, o n the back of the last
years’ monetary tightening. Although private domestic d emand is expected to
pick up in the second half of the year, disinflationary impacts of the significant
slowdown observed in the past four quarters is expected to last for a while. In
this respect, inflation is expected to further decelerate owing to the lagged
effects of strong monetary tightening, notwithstanding the risks related to
energy and food prices.
19. The developments in international liquidity condit ions and credit markets are
closely monitored. The Committee reemphasizes that these developments
should be evaluated with a medium term perspective. Furt her deepening of
the international credit and money market concerns is like ly to affect the
Turkish economy as well as other countries. Such a developme nt would lead
to a tightening in credit conditions and thus support th e disinflation process in
the medium term through the demand channel. In fact, recently the banks
have been less willing to extend credits and the downward trend in consumer
loan rates has subsided. Besides its impact on domestic deman d, the
Committee members have highlighted that recent developm ents in global
credit markets have raised the concerns of a slowdown in glo bal economic
activity, increasing the downside risks on external demand.
20. Accordingly, recent developments on inflation as well as domestic and global
growth prospects imply an improved outlook for medium te rm inflation.
Moreover, the Committee assesses that global developments a re likely to
restrain both the domestic and external demand, increasin g the downward
risks on achieving the 4 percent target in the medium ter m. As explained
through the main policy documents on the general frame work of the inflation
targeting regime, the Central Bank will be equally r esponsive to the upside
and downside risks to attaining the target. Observing the higher downside
risks on medium term inflation implied by recent develop ments and referring
to the conditional statement stipulated in the July Inf lation Report, the
Committee decided that current conditions call for initi ating the measured rate
cuts mentioned in the Inflation Report, and lowered t he policy rates by 25
basis points. The Committee underlines that the current monetary policy
stance continues to be restrictive.
21. Besides the developments in global markets, other imp ortant risks to the
inflation outlook can be described as follows:
22. Significant hikes in public expenditures were the mai n factor restraining the
disinflation process in the first half of the year. Adhe ring to the government’s
budget projections, the Committee’s medium term inflat ion outlook rests on
the assumption of a significant slowdown in public expendi tures during the
second half of the year. Developments on the opposite di rection would pose
risks to the aggregate demand, and therefore to the me dium term inflation
outlook. The Committee closely monitors the developments in public
23. Food inflation continues to be a risk to the inflat ion outlook. Not only the
volatile vegetable and fruit prices but also the adverse d evelopments in grain
products  owing to low crop yields driven by drought conditions  are affecting
the food prices. The projections on the harvest of grain products for 2007
suggest that these developments may persist for a while. Sustained increases
in international soft commodity prices, especially for wh eat and corn, add to
the risks on food prices. The Committee members think that monetary policy
should not react to the volatility in food prices so long as the second round
effects are contained.
24. Oil prices have continued to rise recently. Although strong domestic currency
limits the impact of oil prices on domestic prices, past cumu lative increases in
oil prices require caution for second round effects. Especia lly, uncertainty
pertaining to the electricity prices are considered as a m ajor risk factor for the
medium term outlook.
25. Inflation expectations remain sticky. Despite the signi ficant fall in inflation in
line with the Committee’s projections, medium term expe ctations have not
shown any improvement. Although survey based expectations a re among the
main indicators monitored by the Central Bank, the Com mittee observes that
their information content can vary in time. In particul ar, the Committee
members perceive the existing stickiness in expectations as more of a
structural phenomenon arising from transition from high to low inflation
episode. Therefore, the Committee predicts that inflat ion expectations would
eventually adjust to lower levels, as the inflation furt her decelerates in the
medium term. At the same time, the Committee believe s that Central Bank
can have an active role in realigning public’s inflation expectations by putting
more emphasis on its own institutional forecast.
26. These risks not only require the monetary easing pro cess to be cautious and
measured, but also increase the degree of data dependency of the fortcoming
policy decisions. The exact timing and extent of further e asing may vary with
the incoming information on global liquidity conditio ns, external demand,
public expenditures and other determinants of medium term inflation outlook.
27. Should the risk perceptions deteriorate significantly in the forthcoming period,
the Central Bank may resort to an active liquidity mana gement strategy to
contain the short-term effects of a possible volatility in the financial markets.
28. Under current conditions, the role of fiscal policy a nd structural reforms are
critical for improving the resilience of the economy agai nst global shocks. In
this respect, the European Union accession process and the im plementation
of the structural reforms envisaged in the economic progra m remain to be
important for long-term stability. Advances in structural reforms that would
enhance the quality of fiscal discipline are monitored cl osely with a special
emphasis on macroeconomic and price stability.