SUMMARY OF THE MONETARY POLICY COMMITTEE DISCUSSIONS
Central bank: tcmb | Type: decision | Date: 2006-01-27

No: 2006-6
27 January 2006
SUMMARY OF THE MONETARY POLICY COMMITTEE DISCUSSIONS
Meeting Date: 23 January 2006
Inflation Developments
In December, significant increases in the prices of tobacco product s and other
increases in household goods and various goods and services groups adversel y
affected inflation. On the other hand, fruit and vegetable prices, which had
significantly increased in November, decreased in December to a great extent. With
7.72 percent, annual inflation was realized close to the target.
VAT cuts made in food, health and education sectors in the first quart er of
2005 limited price increases. Even if the downward course in the infl ation trend
continues, the decline in annual inflation may be interrupted in the upcomi ng months,
due to the base effect caused by the VAT cuts and the fact that t he price increase on
tobacco products in December will also be reflected in the January inflation.
Considering the fact that price increases in tobacco products and oil led to
more than 2 points of increase in inflation in 2005, it can be said that the difference
between the current trend of inflation and the 2006 target is not significant. Moreover,
the decline observed in the growth rates of the special CPI indices in the second half
of 2005 confirms that the downward trend in the main course of inflation cont inues.
Although some upward movements were again recorded in the said aggre gates in
December, it is rather early to decide whether this development will turn into a trend
or not. As a matter of fact, inflation expectations also continued t o improve in the last
quarter of 2005. As of January 2006, the end-year inflation expectation is 5.7 percent.
Although inflation declined by 1.6 points throughout 2005, inflation expectations for
the next twelve months decreased by 2.9 points. This development shows tha t the
secondary effects of oil prices will be limited, at least i n the short-term.
Producer prices maintained their favorable course. Excluding those it ems
directly affected by petroleum products, it is observed that price increases in the
manufacturing industry are at very low levels. This low level of increase is believed to
be related to productivity increases, the strong position of the New Turkish lira and
increased foreign competition.
The rigidity of price increases in the services group continues. In the process
of the economic revival and structural transformation, the differentiation in the growth
rates of goods and services prices became more evident. The rig idity in services
inflation mainly stems from the continuity in the demand for service s and the
backward-indexation behavior in services pricing. Considering the high pr oductivity
increases in tradable goods and the structural transformation process in the economy,
it may seem normal that the services group inflation continues to be significantly
higher than the goods group price increase. However, the supply gap in the housing
sector in recent years and the resulting rapid increases in house prices are observed to
exert additional periodical pressure on the prices of the related se rvices items. This
assessment draws support from the fact that price increases in the subgroup of rents
within the CPI and in those groups, where rents are significant input costs, are almost
at same levels with those in 2004, despite the continued downward trend i n inflation.
In this respect, it is anticipated that the price increases i n the services group will
continue to adversely affect inflation in 2006 as well, due to the st ructural
transformation experienced by Turkey and the pricing habits peculiar to a period of
high inflation.
Short-term forecasts made in the light of these evaluations indic ate that annual
inflation will slightly increase in the first quarter of 2006, but decline again starting
from the second quarter onwards.
Factors Affecting Inflation
The data recently released on sales, consumption indices and consumer
tendency surveys provide signals for the continuation of the revival in consumption
demand, especially the demand for durable goods. Furthermore, according to Turkstat
data, there is a significant decline, compared to the previous ye ar, in the number of
firms that cited insufficient demand in the domestic market as one of the reasons for
operating under full capacity. This indicates that the domestic dem and is not sluggish
at the current level.
The indicators regarding investment expenditures point out that the rapi d
growth of investments continues. According to the seasonally adjusted data, increases
in production continue in the machinery-equipment, office machinery and ele ctrical
machinery and appliances sectors. The data on domestic sales of com mercial vehicles
and the import of capital goods also indicate that the revival in i nvestments continues.
In the Business Tendency Survey, the investment tendency and the expect ations for
credit interest rates expected in the next 12-month period also support t he strong
growth tendency of investments. Hence, this situation is considered as a factor that
will contribute to the continuation of the increases in productivity des pite the high-
rated increase in the demand for non-agricultural labor force.
The structural economic reforms should continue for the sustainability of gains
in productivity. The efforts made to reduce the role of the public se ctor in the
economy, in terms of both financial burden and also production activity, cons titute an
important part of this process. The privatization performance atta ined in 2005 will
provide a further lift to productivity in a more competitive environm ent, as well as
contributing to the financing of the current account deficit. The priva tizations in
energy and communication sectors in 2005 are considerable developments in this
respect. In fact, in the scope of structural arrangements, it is observed that the energy
sector has displayed rapid increases in productivity and made contribut ions to
industrial production in a stable manner since 2003. Therefore, the continua tion of the
structural arrangements such as the enhancement of competitiveness and
improvement of the investment environment, which would boost the increas es in
productivity, is of great importance.
Industrial production, which is one of the basic economic indicators for
economic activity, continues to increase in a stable manner. The high level of the real
sector confidence index indicates that the increase in industrial produc tion will
continue, at least in the short term. However, the fact that c apacity utilization rates are
at lower levels compared to the previous year, limits the eff ects of the revival in
economic activities reflected on prices. Considering the fact tha t the increases in
investments continued throughout 2005, a similar outlook is expected in the upcoming
period as well.
Despite a relative stable trend in annual increase rates of c onsumer credits in
the last period, they still maintain their high levels. Decli ning interests and extending
maturities in line with the normalization process of the economy and the deterioration
in inflation expectations lead to a reduction in domestic government borr owing and
support the credit supply by changing banks’ portfolio preferences. The fi nancing
program announced by the Treasury for 2006 provides significant signals f or the
continuation of the said tendency in the upcoming period.
The substantial decline in credit interest rates an d the gradual extension of
maturities caused by the normalization process of t he economy made credit utilization
more appealing. Hence, the demand for credit increa sed substantially. There is no doubt
that these developments that led to an increase in both credit supply and credit demand
support domestic demand. However, it should be taken into consideration that the impacts
of intense credit utilization on expendable incomes and the continuation of fiscal
discipline are the factors that stabilize domestic demand. At this point, rapid credit
expansion is considered as a development that should be followed closely a s to price
stability and financial stability.
In conclusion, it is expected that the contribution of demand to the decline in
inflation in the upcoming period will remain limited compared to previ ous years.
Crude oil prices play an important role in the contribution of import pri ces to
inflation. In 2005 crude oil prices displayed a substantial rise. Des pite a downward
trend in crude oil prices towards the end of the year, this trend re mained temporary
and prices restarted to increase in early 2006. This development conf irms the
forecasts that the upward trend in oil prices would also continue to be a risk factor
with respect to inflation in 2006. Even if the current price level of crude oil is
maintained, the effects of crude oil prices on inflation through input cos ts will
continue for a while. Nevertheless, these effects are not expec ted to deteriorate
medium-term expectations.
Monetary Policy
While making its decisions, the Monetary Policy Committee focuse s on the
consistency of the medium-term outlook of inflation with the targets by taking into
account the lagged effects. The period, during which the lagged eff ects are most
intense, covers around one and one and a half year period. No prompt response s are
given to exogenous shocks, the medium-term targets are emphasized a nd policy
response is spread over time. The Monetary Policy Committee’s reaction to the
increments in tobacco prices in December and to the rise in crude oil prices in January
shall be evaluated within this framework.
Likely fluctuations in international liquidity conditions and global risk appetite
are regarded as factors that create uncertainties with respe ct to the inflation outlook.
Due to historic lows in long-term interest rates in developed countr ies, international
funds have been flowing to developing countries that are taking important steps
towards stability, such as Turkey. In the case that this trend i s reversed, fluctuations
may occur in financial markets. Even if recent developments provi de some signals for
the continuation of this trend in 2006, shocks arising in financial markets may have an
effect on inflation within the context of current economic conditions in T urkey.
The Monetary Policy Committee has concluded that the recent data r eleased
since the last Monetary Policy Committee Meeting have not led to a significant
change in the inflation and monetary policy outlook. It is estimated t hat although the
downward trend of inflation might be interrupted in the first quarter of 2006, it would
resume its trend starting from the second quarter of 2006. Despite t his downward
trend, in the light of current data, year-end inflation is most li kely to be above the 5
percent end-year target. The major reasons behind this argument ar e the sustained
price rigidities in the service sector, the diminution of support pr ovided by supply-
demand conditions to inflation, the persistence of uncertainties about oil prices and
international liquidity conditions and the fact that the other favorable factors have not
been effective enough to offset these negative developments. As a result, it has been
decided to keep the short-term interest rates at the CBRT Inter bank Money Market
and at the Istanbul Stock Exchange Repo-Reverse Repo Market unchanged.
In the light of currently available information, short-term inter est rates are less
likely to move upward in the medium-term, rather than going downward or remaining
stable. In the near future, however, short-term interest rates are more likely to remain
stable. This policy perspective will help inflation stay in line with the target path
around mid-2007.
Meanwhile, it should be underlined that any new data and information
associated with the inflation outlook in the next period will make the M onetary Policy
Committee revise its stance about the future.
targeting strategy as of January 2006. The first inflation report of the inflation
targeting period will be published on the official website of the CB T on 31 January
2006. In the new period, the Inflation Report will be one of the main comm unication
means of the Monetary Policy Committee. In the quarterly reports , recent economic
developments will be explained and the general macroeconomic outlook will be
evaluated so as to shed light on the course that medium-term inflat ion will assume.
Additionally, inflation projections will be presented.