SUMMARY OF THE MONETARY POLICY COMMITTEE MEETING
Central bank: tcmb | Type: decision | Date: 2008-07-17

No: 2008 – 20
28 July 2008
SUMMARY OF THE MONETARY POLICY COMMITTEE MEETING
Meeting Date: July 17, 2008
Inflation Developments
1. Consumer prices were down by 0.36 percent in June, br inging annual inflation
down to 10.61 percent. This development was mainly dri ven by the fall in the
annual rate of increase in unprocessed food prices, notwit hstanding ongoing
rapid increases in processed food and energy prices. The sur ge in food and
energy prices accounts for 6.80 percentage points of annua l inflation as of
2. The Monetary Policy Committee (the Committee) not ed that unprocessed food
prices have been relatively favorable in recent months with a decline of around
10 percent in June, which is a significant fall even if co rrected for seasonal
factors. The decline can largely be attributed to fresh fruit and vegetable prices
that dropped by a remarkable 21.69 percent due to red uced exports. As a
whole, the group’s annual inflation fell to 1.60 per cent. The Committee noted
that the correction in unprocessed food prices might be pa rtially reversed by
the renewed exports to Russia in early July.
3. In contrast, processed food prices continued to increase, mainly due to a
steep rise in bread and grain prices that hit a monthly rate of 4.11 percent in
June. Yet, inflation in processed food excluding bread a nd grains has
displayed some moderation compared with the past four m onths. The 2008
harvest is likely to produce better yields than last year, helping processed food
inflation to moderate in the second half of the year.
4. Energy prices increased by 1.75 percent in June amid r ising fuel and energy
(natural gas) prices, pushing the group’s annual inflati on up to 19.8 percent.
Energy prices are expected to rise further in July due t o increased electricity
rates. New electricity tariff rates, which have been eff ective as of July 1, are
likely to have a direct effect of about 0.5 points to CPI inflation.
5. Annual inflation in clothing and footwear moderat ed in June, while inflation in
durable consumer goods increased. Current demand and cost conditions in
the clothing sector lead to a decline in relative price of clothing. Moreover, the
weakening of the Turkish lira between January and April continued to have
lagged impacts on prices of durable goods, albeit to a lesser degree in June.
6. Annual services inflation remained flat in June. The annual rate of increase in
prices for catering and transport services remained elevat ed due to
developments in food and energy prices. On the other hand, annual inflation in
services other than transport and catering have declined by 0.44 percentage
points over the previous month.
7. Although second-round effects of rising oil and food prices, lagged impacts of
exchange rate pass-through, and last year’s low base have led to an increase
in core inflation indicators during the second quarter o f the year, core inflation
indicators registered a modest decline in June in seasonall y adjusted terms.
Moreover, medium-term inflation expectations seem broa dly contained in July,
after having deteriorated over recent months.
8. The Committee also noted that the hikes in electricit y rates and the last year’s
low base would lead to a significant but temporary rise in annual inflation in
Factors Affecting Inflation
9. Recent readings on supply and demand conditions are i n line with the outlook
presented in our April Inflation Report. Gross Domestic Product (GDP) in the
first quarter grew by 6.6 percent in annual terms.
10. Although annual percentage changes suggest a vigorou s GDP growth,
seasonally adjusted figures point to a quarterly growth rate of around 0.8
percent. The year-on-year growth rate is largely driv en by the low base effect
from the same period last year. The Committee thus emp hasized that
seasonally adjusted figures are key to a sound assessment of the main trends
in economic activity. Overall, seasonally adjusted figure s suggest an ongoing
but moderating economic activity.
11. On the expenditures front, GDP growth was mostly d riven by private demand,
whereas public expenditures had a limited contribution to growth. Although
total final domestic demand increased by 7.5 percent comp ared with a year
earlier, it posted a quarterly decline in seasonally adjusted terms.
12. With exports having accelerated in recent months, the negative contribution of
net external demand to growth has been smaller than t he two preceding
quarters. Compared with a quarter ago, the contributi on of domestic demand
to growth has fallen while that of net foreign deman d has picked up on a
seasonally adjusted basis.
13. Recent indicators point to a further slowdown in con sumer demand in the
second quarter. Consumer confidence indices were down from a quarter ago,
while the slowdown in real consumer loans continued. The seasonally
adjusted CNBC-e consumption index continued to fall in the second quarter.
The production of chemicals also declined further. Furnit ure manufacturing
picked up in the second quarter, yet remained weaker tha n it was in periods of
vigorous demand. Domestic sales of automobiles displayed a significant fall
during January-June period. Imports of consumer goods also declined during
the same period, particularly due to a dramatic decline in the demand for
passenger cars.
14. Investment demand followed a similar pattern to co nsumer demand in recent
months. Domestic sales of light and heavy commercial vehicl es were weaker
compared to the previous quarter, while the production of machinery-
equipment and electric machinery remained flat. Import s of capital goods were
down in quarterly terms during January-June on the back of a slump in
transport vehicles. Excluding those vehicles, imports of in vestment goods
were still falling, albeit more modestly.
15. Despite a slight rebound in the first quarter of 2 008, housing permits, which
have been flat since early 2006, remained stable in th e second quarter in
seasonally adjusted terms. The total number of construction permits in the first
quarter was down by 1 percent from a year ago. The slo wdown in the private
construction sector is even more notable once the positive contribution from
the public sector is excluded. Moreover, the fact that pr oduction of nonmetallic
minerals grow at a lower pace than the exports suggest t hat the domestic
construction activity has continued to moderate.
16. External demand remained strong. The export quan tity index increased by
18.2 percent in the first quarter, and by 11.4 percent during April-May in
annual terms. Seasonally adjusted figures point to an o ngoing yet slightly
moderating growth in exports in real terms. The robust pace of exports and the
recent slowdown in imports suggest that the contribution of net exports will be
higher in the second quarter compared to the previous quarter.
17. Although external demand remained robust, annual growth rate in industrial
production moderated to 4.2 percent during April-May period. Seasonally
adjusted figures suggest that industrial production expan ded at a subdued
pace during the first quarter and grew moderately in the second quarter.
18. First quarter data on the labor market point to a modest recovery in aggregate
terms, although employment in services continue to slow d own. During the
March-May period, non-farm employment rose by 2.4 percent over a year ago,
while non-farm unemployment fell by 0.1 points to 12 .3 percent. The
Committee emphasized that current conditions in the lab or market continue to
restrain the unit labor costs and domestic demand.
19. Labor productivity indicators based on the value-ad ded in the non-farm sector
continued to rise in the first quarter, partially offse tting the cost-push factors
imposed by surging world oil and commodity prices on the real marginal costs.
20. In sum, difficulties in international credit markets continue to restrain the
domestic demand, while external demand remains relativ ely robust. Overall,
aggregate demand conditions continue to support disinflation
Monetary Policy and Risks
21. The meeting agenda also included an assessment of the inflation forecasts
and their underlying assumptions to appear in the July Inflation Report.
Despite the favorable developments in the unprocessed fo od inflation,
processed food prices increased at a faster pace than anticip ated. Therefore,
the Committee envisioned a slightly higher path for t he food prices compared
to the previous Report. Considering that oil prices hav e been drifting at
significantly higher levels than assumed in the previous Report, the Committee
noted that the revised assumptions for oil prices should i ncorporate some
room for caution.
22. Consequently, inflation forecasts, which incorporate the revised assumptions
for oil and food prices, suggest that inflation will sta y at high levels for a short
period before gradually moderating towards the 7.5 p ercent target by the end
of 2009. The Committee underscored that, adverse impact s of the supply side
shocks on the economy would be more limited should the eco nomic agents
align their expectations for the next three years with the target rates of 7.5
percent, 6.5 percent and 5.5 percent, respectively.
23. The revised inflation forecasts are based on quite co nservative assumptions
for food and energy prices, implying that downside risks on these factors are
as significant as upside risks. Should the upside risks materia lize, monetary
policy will be conducted so as to minimize upside deviati ons from the targets.
Downward surprises in food and energy prices, on the oth er hand, will be
perceived as an opportunity to bring inflation back to target in a shorter period
than envisaged in our baseline scenario.
24. Despite the expected decline in inflation in the m edium term, uncertainties
exist regarding the degree of inflation persistence. Lo ng-lasting supply shocks
have been keeping headline inflation at elevated lev els and thus increasing
the risk of rising backward looking schemes in the wage and price setting
behavior. Although the widening output gap should con tain the second round
effects of the supply shocks, the exact pace of disinflation would still depend
on the extent new inflation targets serve as a strong r eference for economic
agents. Having this in mind, the CBT will continue to focus on enhancing the
credibility of the new inflation targets. In this conte xt, developments in the
general pricing behavior and the underlying inflatio n trends will be monitored
25. International financial markets remain fragile and the credit conditions continue
to tighten up. The eventual impact of the financial t urmoil on the global
economic activity is yet to be seen. Moreover, rising comm odity prices
continue to be a threat for price stability. These uncer tainties have been
dampening the risk appetite and thus slowing down the ca pital flows to
emerging markets, leaving these economies susceptible to shifts in the market
sentiment. Domestic uncertainties have exacerbated these e ffects, as
manifested by the significant rise in the sovereign credi t risk of Turkey in the
first half of the year, compared to the average risk pr emium of emerging
economies. The CBT will not display a sharp reaction to temporary fluctuations
in the financial markets, unless there is a long lasting d eterioration in
expectations and a significant worsening in the general pricing behavior.
26. Finally, our medium-term projections assume that go vernment expenditures
will evolve in line with the official projections and that there will be no further
increases in indirect taxes or administered price adjustmen ts, except those
required by the automatic pricing mechanisms. Any deviat ion from this
framework may lead to a revision of the outlook for in flation and monetary
27. Regarding the monetary tightening since May, the Committee indicated that
the current level of the policy rate was supportive of disinflation. Yet, it was
also emphasized that ongoing uncertainties and supply sid e shocks continued
to pose risks on inflation. Therefore, the Committee me mbers assessed that
monetary policy should continue to maintain a cautious st ance. Accordingly, a
further measured rate hike would be considered, when ne eded, to prevent the
potential second-round effects of the risk factors. The Com mittee once again
underlined that the timing of a possible future rate hike would depend on
developments in global markets, external demand, fiscal policy
implementation, and other factors affecting the medium term inflation outlook.
28. The Committee also indicated that it would be usef ul to clarify some issues
related to operational aspects of monetary policy. Excess liquidity sterilized in
the overnight market has been shrinking in the second hal f of 2008 due to a
reduction in the amount of FX purchased through regula r auctions; fall in
Treasury’s foreign debt rollover ratio, and rising mon ey demand. Accordingly,
the Central Bank has provided the required liquidity into the system via repo
auctions, targeting overnight interest rates to materia lize at levels close to
Central Bank borrowing rate. Still, there has been som e undesired volatility in
the overnight rates due to unforeseen movements in the liquidity, mainly
arising from the banks’ demand for reserves. Considering these
developments, the Committee has decided to reduce the m argin between the
borrowing and the lending rates by 50 basis points.
29. Current projections do not point to a permanent sh ortage in the liquidity. In
case of a temporary shortage, the Central Bank will pro vide the required
liquidity through repo auctions, targeting the overni ght interest rate in the
money market to stay close to the Central Bank borrowing rate. Hence, the
key policy rate will continue to be Central Bank’s overnight borrowing rate.
30. Prudent monetary policy is a necessary but not a suff icient condition for
attaining price stability. The support from fiscal policy and structural reforms
are also critical in this respect. Sound fiscal policy has be en one of the main
factors in driving inflation down to single digits. The role of fiscal policy will
continue to be critical in the road to price stability. Preserving the resilience of
the economy, especially under current conditions, require s the continuation of
fiscal discipline and structural reforms. In this respect, th e European Union
accession process and the implementation of structural refor ms envisaged in
the economic program remain to be of utmost importance. In particular,
advances in structural reforms, which would improve the q uality of fiscal
discipline and enhance the productivity, are monitored closely by the CBT with
regard to their implications on macroeconomic and price stability.