SUMMARY OF MONETARY POLICY COMMITTEE
Central bank: tcmb | Type: decision | Date: 2006-09-07

No: 2006-43
September 07, 2006
SUMMARY OF MONETARY POLICY COMMITTEE
DISCUSSIONS
Meeting Date: 24 August 2006
Inflation Developments
1. While the Consumer Prices Index (CPI) increased by 0.85 percent in Jul y,
annual inflation reached 11.69 percent. The lagged effects of the
fluctuations in exchange rates in May and June on prices, the high increas es
in food prices beyond the seasonal trend and the continuation of the
unfavorable course of energy prices stood as the main determinants of hi gh
inflation in July. While the increases in the prices of food and non-al coholic
beverages group made up 0.39 percentage points of CPI inflation in July,
increases in the energy prices accounted for 0.30 percentage points of
monthly inflation. In previous reports and announcements it had been stated
that the effects of exchange rates on inflation would be felt strongly . In this
context, the rise in annual inflation in July is not considered as a sur prise by
the Monetary Policy Committee (the Committee).
2. In July, rapid increases in good prices continued. The rise in prices of the
goods stemmed mainly from the high increases in unprocessed food prices
since the last quarter of 2005, which results especially from the a dverse
weather conditions. Besides, high increases in international oil prices and
other commodity prices as well as exchange rate developments became
influential in the high course of inflation in the goods group.
3. Price increases in the services group lost pace partially compar ed to the
previous year. However, it is notable that high annual increases in pric es of
rent, hotel-accommodation and transportation services continued.
Considering the fact that rent contracts are generally indexed to pa st
inflation, no significant deceleration is expected in rent increases in the
short run. It is estimated that such a slowdown process will be obser ved
with lag in the medium term. Meanwhile, prices of transportation ser vices
follow a course parallel to that of oil prices.
4. In July, all Special CPI Aggregates registered high increases. Annua l
inflation of the CPI excluding energy, unprocessed food, alcoholic
beverages, tobacco products and gold (SCA D*), which is calculated by
excluding temporary factors in order to measure the general inflation trend,
continued to rise mainly due to the lagged effects of exchange rate
movements on durable goods.
5. It is observed that the recent appreciation trend of the New Turkish lira
(YTL) led to a significant slowdown in the rate of increase in pri ces of
durable goods in August. Moreover, it is expected that certain groups such
as fuel oil and gold, which are directly affected by exchange rates, will push
down the consumer prices index in August. As a result of these
developments and also in line with the disappearance of the impact of pr ice
increases in tobacco products on annual inflation, which was experienced in
the same period of last year, annual inflation may decline in August.
Factors Affecting Inflation
6. Recently available data have confirmed our earlier conjecture that economic
activity would slow down, albeit not as significantly, in the second half of
2006 due to sluggish domestic demand. In the recent period, increases in
relative prices of goods with a high imported component and the rise in
credit interest rates are affecting demand for durable goods unfavorabl y. In
July, consumer confidence indices continued to fall in line with the decl ine
in the tendency of spending on houses, automobiles and other durable
goods. The downward trend in credits continued in August as well.
Liquidity shortages in the market, rises in interest rates and the decline in
banks’ appetites to extend credits will continue to restrain the incr ease in
credits. Meanwhile, indicators related to the volume of sales in the domestic
goods market and the expectations regarding the new orders coming from
the domestic market for the next three months, collected as part of the
Business Tendency Survey (BTS), maintained the upward trend in July,
which was first experienced in June following the rapid decline observed in
May. This development encourages the belief that the unfavorable effects of
fluctuations in May and June on the general consumption tendency may be
temporary.
7. No significant deterioration is observed in the indicators related to the
investment demand. Imports of capital goods decreased in June due to
foreign exchange rate movements. Nevertheless, production volume in the
machinery-equipment, electrical machinery and office equipment sect ors
increased in the same period. Moreover, one of the BTS indicators, the
investment tendency over the next 12 month-period increased in July and
August following the slump in June. These developments support our
projections that the unfavorable impact of fluctuations in May on
investment would be limited. The sustained high production level in the
non-metallic minerals sector, which provides raw materials to the
construction sector, point to the fact that despite the slowdown in housing
loans, the strong investment tendency in the construction sector continues
thanks to the already started projects.
8. The rapid increase in exports fuelled by the sustained vigorous economic
activity in Europe positively affects the performance of the manufa cturing
industry. It is forecasted that the manufacturing industry production would
grow at a high pace in July just as it did in June. It is estimate d that annual
growth in industrial production will slightly decrease as of August.
9. The continued rise in relative labor productivity in the manufacturing
industry keeps restricting the unit labor costs. There is no significant decline
in the investment tendency yet, and this can be considered as a favorabl e
development with respect to the course of the productivity in the medium
10. To sum up, factors such as the continuation of the rise in investor
confidence in July; the continued rising tendency in consumption items
other than motor vehicles and housing; the improved expectations for
domestic sales and orders over the next three months; and the strong fore ign
demand all indicate that the slowdown in total demand might be limited.
Risks and Monetary Policy
11. The effects of the measures taken in June on demand-pull inflation wi ll start
to take effect towards the end of the year and will become more a pparent by
the first quarter of 2007. Since the impact of monetary policy decis ions on
inflation manifests itself after a certain period of time, the Central Bank
needs to act with a medium-term perspective. However, the economic uni ts’
tendency to behave in a short-term perspective due to the persistence of
their past habits appears as a risk factor that could undermine the
effectiveness of policy measures. It has been observed on several oc casions
in the past that ascribing undue implications on a single month’s inflati on
figure without deep analyzes of the outlook of factors affecting inflat ion
and the developments in the sub-items would increase fluctuations in the
financial markets. It should be underlined once more that, rather than shor t-
term developments in inflation, the trends observed throughout an 18-month
period perspective are important for monetary policy decisions.
12. In August, the deterioration in medium-term inflation expectations ceas ed
and moreover a slight improvement was experienced. Generally, it can be
claimed that the survey participants expect a gradual decline in inf lation in
the next two years. However, medium-term inflation expectations are
significantly above the targets and this emerges as a risk factor in setting
wages and prices. The Committee will keep a close eye on the expe ctations
in the upcoming period and maintain its cautious stance until medium-term
expectations of the economic units converge to the targets. It should be
borne in mind that the continuity of fiscal discipline and structural r eforms
is as important as monetary policy in terms of keeping the expectat ions
under control.
13. The Committee emphasizes that, in terms of attaining the 4-perce nt end-
2007 target, it is significantly crucial that the incomes policy mus t be
pursued consistently with the program targets. Moreover, strict adherence to
budget limits without resorting to adjustments in public prices and taxes are
critical for attaining medium-term targets.
14. There are still uncertainties on the contribution of imported cost fa ctors to
the disinflation process in the upcoming period. The volatile course of
commodity prices at high levels influences the producer prices. Even if the
relative slowdown in demand is expected to ease the pass-through effect
from producer prices to consumer prices, developments in this area are still
being closely monitored.
15. Recently, international liquidity conditions displayed a relatively f avorable
course. The fact that US growth and inflation figures were realize d below
the expectations and thus FED suspended interest rate hikes, has increa sed
the perception that the monetary tightening cycle has come to an end, and
which in turn, reduced volatility in emerging markets. Owing to these
developments, the risk premium indicators for the Turkish economy have
improved moderately. Nevertheless, the picture as to the inflation ri sks in
the USA and whether the FED would deem additional tightening necessary
or not are not yet clear. Besides, even if the monetary tightening in
developed countries comes to an end, it will not necessarily imply tha t the
global uncertainties have disappeared. Recent analyses point out the fac t
that the risk of slowdown in the US economy should not be disregarded.
Under the scenario that this development could happen earlier than
expected, it can be anticipated that global economic uncertainties wil l
16. In line with the assessments above, the Committee perceives that the
medium-term inflation outlook has become slightly more favorable
compared to the previous month. However, there is still need to remain
cautious for inflation because oil and other commodity prices are sti ll
increasing and the expectations are not yet in line with the medium-t erm
17. In the previous Inflation Report, it was stated that a measured monet ary
tightening might be necessary in the second half of the year in order t o be
able to achieve the target for 2007. Committee members made the
evaluation that it was still early to signal that the additional monetary
tightening is over. Accordingly, they reached a consensus that in case of
developments that may adversely affect the medium-term inflation outlook;
the Central Bank would not hesitate – as stated in earlier announceme nts
and reports – to opt for further tightening. Within this framework, the
Committee concluded that maintaining the cautious stance for a while was
essential for converging to the targets at the end of the year 2007. What is
meant by “cautious” stance here is a stance where the Central Bank adheres
to its tight monetary policy and is responsive to even the slightest ne gative
development in terms of medium-term inflation.
18. Following the decisions made on June 25, the excess YTL liquidity in the
market decreased significantly, and hence liquidity conditions tightened.
The actual level of excess liquidity mopped up by the Central Bank in t he
o/n market allows the monetary policy to be conducted more flexibly and
effectively in the period between two subsequent Committee meetings .
Until the next MPC meeting, short-term interest rates are fore seen to
materialize within the 17.50-21.50 band, close to the Central Bank lending
rate of 17.50. However, in case of any extraordinary fluctuations in the
markets, the short-term interest rates could be allowed to mater ialize above
17.50, as long as they remain within the 17.50-21.50 band.
19. Along with all these factors, the continuation of reforms that would enha nce
the competition and investment environment and thus, bolster productivity
increases in the long run, is still of vital importance. In this conte xt, the
continuation of the European Union accession process, and the
uninterrupted implementation of the structural reforms envisaged in the
economic program as planned are crucial. The continuation of the
determined steps taken in recent years in this context will help t he economy
to overcome the adverse changes in the international conjuncture with
minimum cost.