SUMMARY OF THE MONETARY POLICY COMMITTEE MEETING
Central bank: tcmb | Type: decision | Date: 2007-10-16

26 October 2007
SUMMARY OF THE MONETARY POLICY COMMITTEE MEETING
Meeting Date: October 16, 2007
Inflation Developments
1. Consumer prices increased by 1.03 percent in September , bringing year-on-
year inflation rate down to 7.12 percent. As foreseen in the summary of the
previous Monetary Policy Committee (the Committee) Mee ting, annual
inflation continued to decelerate in September, follo wing a temporary rise in
2. The volatility in the prices of fresh vegetables and f ruits impede the
predictability of monthly inflation figures. Moreover, processed food prices
have displayed sharp increases over the last several months, d ue to
temperatures above seasonal averages and drought conditions as well as the
Ramadan effect. The course of food prices has increased the importance of
core indicators excluding the food group. Therefore, the Committee noted that
it would be useful to underscore the ongoing decelerati on in non-food
inflation.
3. Although energy prices continued to rise in Septembe r, at a much higher rate
than the past few months due to soaring crude oil prices, they still supported
the disinflation process in the first nine months of the year. There may be
some price increases in certain energy group items such as el ectricity and
water in the upcoming period. The Committee assessed tha t the impact of
these rate hikes on inflation would be temporary.
4. The slowdown in services prices, which has become evident si nce July, was
quite strong in September, bringing annual services infl ation down by 2.5
percent in the past three months. Although the pace of disinflation process is
particularly noteworthy in rents and restaurants-hotels group, the deceleration
in services inflation is quite visible in other items as wel l. Since the beginning
of the year, annual inflation rate has declined by 3 percentage points in rents
and 5 percentage points in transportation services.
5. The effect of monetary tightening on special CPI ag gregates has been quite
visible. The slowdown in seasonally adjusted monthly incre ases in the widely
cited core indicator, H-index (CPI excluding energy, unpr ocessed food,
alcohol-tobacco and gold), confirms the downward trend in inflation.
6. All in all, notwithstanding the risks related to ene rgy, food and administered
prices, inflation is expected to decelerate owing to the lagged effects of strong
monetary tightening.
Factors Affecting Inflation
7. The Committee assesses that the second-quarter Gross Dome stic Product
(GDP) data point to a moderate growth in domestic dem and and economic
activity. In this period, private and public investments were the main drivers of
domestic demand growth, whereas the increase in private co nsumption
demand was rather limited.
8. Leading indicators for the third quarter point to an ongoing recovery in private
investment expenditures. Domestic sales of commercial vehicles r ecorded
high growth rates in both annual and quarterly terms. While the machinery-
equipment production for the July-August period remain ed below the second
quarter levels, electrical machinery production continued to increase in the
same period, albeit at a slower pace. In the July-August period, imports of
capital goods, an indicator of investment demand, display ed a noticable rise
compared to the second quarter. To sum up, initial read ings in the third
quarter indicated a strong recovery in investment demand, although that
demand is mainly for imported goods.
9. Consumption demand has started to recover in the thir d quarter. The
composition of the aggregate demand has been shifting i n favor of domestic
demand. According to seasonally adjusted figures, domestic sales of white
goods, imports of consumer goods for the July-August perio d, and domestic
sales of automobiles for the third quarter grew signifi cantly over the preceding
quarter. Third-quarter average of the CNBC-e consumpti on index is above its
second-quarter level, and consumer confidence indices confirm the modest
recovery in consumption demand.
10. The Committee assesses that the aforementioned develo pments indicate a
modest recovery in domestic demand, rather than an overhe ating in the
economy, following the slowdown since the second half of 2006. Although
quarterly growth rates of real consumer credit have been somewhat rising
recently, they still remain below the periods where do mestic demand was
more robust. Likewise, domestic sales of automobiles, despit e the recent
recovery in the third quarter, remains at modest levels.
11. Industrial production figures in August and estimate s for September also
confirm the moderate growth in domestic production. Ind ustrial production for
the July-August period increased by 5 percent compared to the same period
last year, while seasonally adjusted figures indicate a sl ight increase over the
preceding quarter. Despite the recent recovery, furnitur e manufacturing, a
sub-sector believed to reflect consumer demand, is still bel ow the level it
reached during the first half of 2006, when the domestic demand was strong.
12. While growth in exports has maintained its strong pace, the rate of increase in
imports has surpassed that of exports in the June-August per iod due to the
recovery in domestic demand and the appreciation of the Turkish lira.
Therefore, it is projected that the contribution of ne t exports to GDP growth in
the second half of the year will be negative.
13. To sum up, readings on recent economic activity are in line with the outlook
presented in the July Inflation Report. While private consumption and
investment demand exhibits signs of recovery, external deman d moderates
and aggregate demand conditions continue to support the disinflation
process. This trend is likely to continue in the upcoming period as well.
14. The upward trend in crude oil prices persisted in th e recent period. In
addition, other commodity prices also continued to be on the rise. Prices of
agricultural products used as main inputs for processed food , such as wheat
and corn, continue to rise. However, the strong domestic cu rrency partially
offsets the rise in crude oil and other commodity prices and curbs input costs.
15. Lagged effects of monetary tightening since the secon d half of 2006 seems to
have curtailed the unit labor costs in the overall economy , primarily in the
services sector. Downward trend in unit labor costs in the m anufacturing
industry confirms this view. Although no wage data for t he services sector is
available, a similar conclusion might well be drawn for this sector in view of
the slowdown in the growth rate of employment and prices.
Monetary Policy and Risks
16. The Committee assessed that the September rate cut d ecision led to a
significant fall in both the medium and long-term int erest rates, reducing the
downward risks on medium term inflation posed by global economic
developments.
17. In light of these developments, the Committee decid ed to continue the
measured rate cuts. The Committee underlines that the cu rrent level of the
short-term interest rates remains restrictive even after th e recent policy rate
cuts. The Committee assesses that, under the current policy stance
envisaging a measured and cautious rate cut cycle, the risks o n attaining the
inflation target in the medium term are balanced.
18. Considering the downward trend in interest rates, the Committee decided to
narrow the gap between borrowing and lending rates i n order to limit the
extent of potential upside fluctuations in overnight int erest rates. In this
regard, borrowing rates are reduced by 50 basis points, while lending rates
are cut by 75 basis points. It should be noted, however, that main policy
instrument of the Central Bank is the overnight borrowi ng rates, and thus the
additional cut in lending rates is merely a technical adjustment.
19. The Committee stated that the timing and extent o f further easing would
depend on the incoming information regarding global liquidity conditions,
external demand, public expenditures and other determin ants of the medium
term inflation outlook. In other words, the future mo netary policy decisions will
be data dependent. Main risks to the inflation and mon etary policy outlook
can be summarized as follows:
20. The Committee closely monitors the developments in i nternational liquidity
conditions and credit markets. As of today, a sharp slowdo wn on global
economic growth is not perceived as the most likely scenario, leading to
continued capital flows to emerging markets. However, tha t the risks in the
financial markets have not yet been adequately priced ne cessitates caution.
The CBT, in case of a heightened risk aversion and a decli ne in risk appetite
towards emerging financial markets, will aim at limitin g the effects of possible
market fluctuations on inflation outlook by pursuing an active liquidity
management strategy, as well as by utilizing other pol icy instruments if
21. Recent volatility in credit markets has partially off set the upside risks to the
aggregate demand mentioned in the July Inflation Rep ort. However, there are
some remaining risks to the demand outlook. On one side, the extent to which
the recent decline in longer-term rates will stimulate the domestic demand is
yet to be observed. On the other side, a sharper-than-e nvisaged slowdown in
global growth will ease both the external demand and, through the tighter
credit conditions, the domestic demand. Financing conditio ns and credit
developments will continue to be closely monitored in the face of these upside
and downside risks. If credit conditions turn out to be mo re favorable than
expected and the domestic demand accelerates, this may lead to a more
cautious policy stance than implied by the baseline scenari o, as well as the
use of policy tools other than short term interest rates, such as required
reserves and alike. Likewise, materialization of downside risks would lead to a
downward adjustment in the policy stance.
22. As of the meeting date, medium term outlook is base d on the assumption that
government expenditure targets will be met in 2008 and incomes policy will
be set in line with inflation targets. On the other h and, the fact that efforts to
readjust the primary budget balance are more focused on increases in
indirect taxes as opposed to expenditure cuts poses a risk to t he predictability
of inflation.
23. The sustained rise in food prices is considered as an im portant risk to the
inflation outlook. Our medium term projection envisages a gradual correction
in which food inflation converges to headline inflation in the medium term.
However, low crop yields in 2007 and recent global tren ds have increased
upside risks to the food inflation. On the other hand, past cumulative hikes
have created a high base in food prices, increasing the po ssibility of a
downward adjustment. Potential volatility in food pri ces continue to pose risks
to the inflation outlook on both sides, since food prices constitute a large
fraction of the CPI index. The Committee will not rea ct to the developments in
food prices as long as the second round effects are contained.
24. There are some uncertainties over the medium term i mpact of the recent
developments in energy prices. Owing to cumulative increases in international
oil and natural gas prices, recently the need to make a sizeable adjustment in
electricity prices has been on the agenda. The price of w ater, classified as an
energy item in the CPI, may also display a significant rise in the last quarter of
2007, although the rate of increase may differ across re gions. Moreover,
international crude oil prices have continued its upward course. Medium term
impact of the rise in energy prices on inflation will b e limited, as long as the
inflation expectations and the price setting behavior rem ains intact. However,
since the energy price is an important factor of producti on, it should also be
added that recent developments in energy prices have compe lled the CBT to
be relatively more cautious. On the other hand, switchin g to a cost-based
automatic pricing mechanism in electricity would reduce th e risks on shortage
of supply as well as on price stability.
25. Turkey has taken significant steps towards price stabilit y in recent years.
However, it is not yet possible to define the current sta te as price stability.
The CBT will continue to exercise its policy instruments to attain price stability
and thus to improve welfare of the society in the mediu m term. During this
process, it is particularly important not to sacrifice long -term permanent gains
in favor of temporary benefits.
26. The support of fiscal policy and structural reforms ar e also critical in achieving
price stability. In this respect, the European Union accessi on process and the
implementation of structural reforms envisaged in the eco nomic program
remain to be of concern. Particularly, advances in structur al reforms that
would enhance the quality of fiscal discipline are monit ored closely with
regard to their implications on macroeconomic and price stability.