SUMMARY OF THE MONETARY POLICY COMMITTEE DISCUSSIONS
Central bank: tcmb | Type: decision | Date: 2006-06-02

No: 2006-24
June 02, 2006
SUMMARY OF THE MONETARY POLICY COMMITTEE DISCUSSIONS
Meeting Date: 25 May 2006
1. The Monetary Policy Committee (the Committee) ta kes its decisions in order to
ensure the consistency of inflation with the medium -term targets. Therefore, the
important point for monetary policy is the information content of the announced
data pertaining to the medium-term outlook of infla tion. Seasonal movements
or one-off shocks on supply and costs may cause une xpected jumps in monthly
inflation. Inflation figures may be higher or lower than the expected level,
especially in periods where prices of some sub-item s such as food and clothing
might display high volatility due to seasonal facto rs. The information content of
the figures for a single month may be limited regar ding the inflation outlook in
the upcoming period. Therefore, the monthly data should be handled cautiously.
Accordingly, during the inflation targeting period, the Central Bank set its main
communication tool as the Inflation Report, publish ed quarterly, rather than
monthly reports. In this framework, the quantitativ e forecasts regarding the
medium-term course of inflation are revised once a quarter. Current data are
carefully monitored and interpreted along with the outlook presented in the
Inflation Report.
Evaluation of Price Developments
2. The price developments in April can be evaluated from two different aspects;
monthly and annual increases:
a. In April, consumer prices displayed a high incre ase of 1.34 percent on a
monthly basis. Regarding monthly price increases, one of the main
factors standing in the forefront is the unfavorabl e impact of price
movements on the food sub-group. This development s temmed from
unprocessed food products. Meanwhile, it is observe d that the price
increases in processed food products are at low levels and pursue a stable
course. This observation indicates that the high in creases in the food
group can be offset by the declines in summer. Besi des, gold prices,
which displayed a rapid rise in April, have been on e of the factors that
led to high monthly inflation figures.
b. While interpreting annual inflation figures, it should be kept in mind that
the prices of items, such as alcoholic beverages-to bacco, energy, gold
and unprocessed food, which are beyond the control of the Central Bank,
displayed high-rated increases in the previous twel ve-month period. If
the growth rate of the index excluding the mentione d products is
analyzed, the main trend of inflation is not incons istent with the
medium-term targets.
c. In summary, although the inflation figures perta ining to April were
above expectations, in light of the evaluations abo ve, they do not include
adequate information that would make us revise our medium-term
perception.
3. It is predicted that in May, the high levels of oil and gold prices along with the
recent developments in exchange rates will lead to a rise of 0.4 percentage
points in the monthly inflation figures solely via gold and petroleum products.
In other words, exogenous factors will not have a f avorable impact on May
inflation. Furthermore, it is difficult to make pre dictions about the prices of
unprocessed food and clothing due to likely seasona l volatilities in May, it will
not be appropriate in this month, as in April, to m ake a specific comment by
only considering the monthly inflation figures with out taking sub-items into
4. The evaluations above are based on the latest pr ice developments. The analysis
of expectations, cost factors and pricing behaviors are of great importance in
the formation of the inflation outlook and the future course of monetary policy.
Factors Affecting Inflation
5. The latest developments in supply and demand dis played a course consistent
with the forecasts presented in the Inflation Repor t. The investment tendency
remained strong and the revival in demand continued without any acceleration
tendency. Moreover, it was seen that the slow-down observed in production at
the start of the year was temporary. However, the C ommittee re-evaluated the
outlook in light of recent developments in financial markets.
6. In the previous Inflation Report, it was project ed that the downward trend in
inflation would continue under the base scenario wh ere oil prices followed a
horizontal course and no unfavorable development wo uld occur in the risk
premium. Moreover, it was clearly stated that the d ifficulty in the predictability
of the global risk appetite and international liqui dity conditions was still a risk
factor. Actually, as part of the funds previously d irected to emerging markets
moved to developed countries that is perceived as m ore secure, this risk has
been materialized. This circumstance has had a nega tive impact on emerging
markets including Turkey and has led to fluctuations in financial markets.
7. These developments have affected short-term infl ation expectations adversely.
However, the fact that the rise in medium-term infl ation expectations has
remained lower compared to the rise in short-term i nflation expectations shows
that the confidence in the disinflation process wou ld continue. Nevertheless,
the gap between expected and targeted inflation rat es, which tends to expand, is
a development that requires a close monitoring for the sake of monetary policy.
8. At this point, in light of recent developments, the future trend of inflation and
the corresponding future monetary policy is of utmost importance.
9. First, we should consider the short-term outlook . Due to the recent fluctuations
in financial markets, the short-term outlook presen ted in the last Inflation
Report has changed. The fluctuations in financial m arkets would have direct
effects on production, demand and costs in the shor t run. A downward trend
would not come as a surprise in the real sector and consumer confidence
indices, which have started to improve in April. Th e rises in prices of capital
goods and interest rates with the fluctuations in f inancial markets will affect the
investment tendency in the short run. Increased int erest rates as well as
decreased relative price advantages in consumer dur ables will shrink
consumption demand and imports of consumption goods will slow down in the
upcoming period. However, due to structural reasons , it is estimated that the
slowdown in imports of intermediary goods will be l imited. All these factors
reduce the probability of a demand-push pressure on inflation in the short term.
10. Despite the slowdown in demand, inflation might be adversely affected in the
short run. The projections presented in last month’ s Inflation Report were based
on the assumption that no sharp turn would emerge i n international liquidity
conditions and that the New Turkish lira would cont inue to contribute to the
disinflation process by retaining its strong positi on. However, based on the
recent developments, these assumptions have become void, at least for the short
run. Prices of sub-groups under the Consumer Price Index such as medicine,
natural gas, oil, diesel oil, LPG, package tours ab road, gold and imported coal
are directly affected by changes in exchange rates very quickly. In other words,
it is inevitable that the fluctuations in exchange rates will influence inflation via
direct cost channel in the short run.
11. However, it should be highlighted here that tha nks to the reduced inflation rate,
the floating exchange rate regime, increased compet ition, and economic
policies focused on stability, pricing behaviors ha ve been changing in the last
couple of years. Within this context, it is project ed that the indirect effects of
exchange rate developments on inflation would be ph ased over in time and the
total magnitude of the effects would depend on whether the movements in
exchange rates are temporary or permanent.
12. Accordingly, the direction and magnitude of th e policy response of the Central
Bank may vary depending on whether the fluctuations are temporary or
permanent. The studies that have been carried out a t the Central Bank indicate
that the indirect effects of exchange rates on infl ation start to accelerate the
third month onwards. Departing from this observatio n, it can be asserted that
most of the indirect effects will be contained if t he fluctuations in the markets
are of a temporary nature . In this case, inflation will soon resume its declin ing
trend and there will be no need to tighten policy r ates. In case the depreciation
in the New Turkish lira gains a long-lasting nature and the rise in the risk
premium continues, the unfavorable effects on infla tion are more likely to
spread to the medium-term and, in such a case, poli cy rates will need to be
tightened in order to meet the medium-term inflation target.
Inflation Trend in the Medium-Term
13. One point should be emphasized with regard to i nflation trends in the medium-
term. Despite the deterioration in the risk appetit e and international liquidity
conditions, many other factors that supported the downward trend in inflation in
recent years are very likely to continue to contrib ute to this trend in the
upcoming period. It is anticipated that unit labor costs will remain limited in the
forthcoming period, due to the high labor force par ticipation rate resulting from
demographic factors; tougher competition, driving f irms to maintain increases
in productivity; and structural transformation in t he agricultural sector. Clearly,
this anticipation is based on the assumption that t he income policy will also
continue to be pursued in line with the inflation t arget. In this respect, it is
expected that the contribution of supply and demand conditions to the
disinflation process will continue.
14. Another factor that supported the downward tren d in inflation in recent years is
the fact that low labor costs in countries such as China and India restrained the
increases in prices of tradable goods through inter national competition.
Considering the rapid rise of the Turkish economy’s level of integration with
the world, it is anticipated that the said mechanis m will continue to contribute
to the disinflation process in the upcoming period.
15. The steps already taken and those planned towar ds structural adjustments in
areas of fiscal discipline, taxes, social security and the European Union
accession process will provide support to the fight against inflation via
expectations. As long as progress is made in struct ural adjustments that will
ensure fiscal discipline and economic stability, th e impacts of exogenous
shocks will remain limited.
16. Although the support of all these factors to th e disinflation process is expected
to continue in the medium term, none of them ensure that inflation will be
consistent with medium-term targets. The commitment s of the Central Bank
stand as the most solid assurance in this regard. I t should be emphasized once
more that a monetary authority with instrumental in dependence, whose main
objective is to establish price stability, will cer tainly respond if there are strong
indications that inflation could considerably devia te from targets in the medium
17. End-year inflation targets for 2006, 2007 and 2 008 have been set at five
percent, four percent and four percent, respectivel y. In the light of available
information, though inflation is very likely to be above the target at end-2006,
the Central Bank will give the appropriate response in order to maintain
consistency between the 2007 inflation and the targ et in the medium-term
perspective.
18. Price stability is a sine qua non for macroeconomic stability and sustainable
growth. Significant steps have been taken towards t his end in recent years. The
Central Bank will continue to play its part in buil ding on these achievements. In
order to prevent persistent exogenous shocks from t hreatening price stability, a
prudent monetary policy as well as fiscal disciplin e should be maintained. It
should be kept in mind that the main determinant of sustainable non-
inflationary growth is the confidence in lasting ma croeconomic stability. In this
context, ongoing determination in the implementatio n of structural regulations
that would further increase the quality of fiscal d iscipline and continuance of
reforms, which would improve the competition and in vestment environment
and support productivity increases in the long term , are of critical importance.
Besides, avoiding any implementation that would dam age the expectations
about economic fundamentals is crucial for sustaini ng the resilience of the
economy to exogenous shocks.
19. In consideration of the available information, it should be noted that, although it
is still early to change the medium-term outlook, p olicy rates are less likely to
decrease in the short term. In the upcoming period, policy rate decisions will be
conditional on international liquidity conditions, changes in the risk premium
and other developments. The direction and magnitude of policy response can
vary depending on whether the effects of fluctuatio ns are temporary or
permanent.
20. It should be emphasized that any new data and i nformation associated with the
inflation outlook will lead the Monetary Policy Com mittee to potentially revise
its stance regarding the future.