SUMMARY OF MONETARY POLICY COMMITTEE
Central bank: tcmb | Type: decision | Date: 2006-10-09

No: 2006-45
09 October 2006
SUMMARY OF MONETARY POLICY COMMITTEE
DISCUSSIONS
Meeting Date: 26 September 2006
Inflation Developments
1. The recent deceleration in the rate of increases in price s of the items such
as energy, unprocessed food, alcoholic beverages-tobacco and gold,
which had played a significant role in the rise in infl ation in the previous
year, has affected the annual inflation figures favora bly. In August, annual
inflation rate declined to 10.26 percent. One of the determinants of this
development has been the removal of the impact of the price increases in
tobacco products that had been experienced in the same pe riod of the
previous year. Moreover, the continuance of the partia l correction in
unprocessed food prices strengthens the view that the high price
increases observed in the food group during the last 12- months mainly
originated from supply-oriented factors.
2. The annual rate of increase of the price index that is calculated by
excluding energy, unprocessed food, alcoholic beverages, t obacco
products and gold continued to increase in August. The la gged effects of
exchange rate movements had played an important role in this rising
trend. Although the prices of fuel oil, gold and techn ology-intensive
imported products declined in August along with the app reciation of the
New Turkish Lira (YTL), the unfavorable lagged effects of the fluctuations
experienced in May and June on prices are still observabl e, albeit at a
slower pace for many products. Meanwhile, the increases in prices of the
durable goods that accelerated considerably after May slo wed down
significantly in August, as it had been foreseen in the previous
announcement regarding the summary of Monetary Policy Committee
(Committee) discussions.
3. The Committee members consider that it would be helpfu l to prepare the
public in advance for likely fluctuations in inflation in the upcoming months.
It is expected that the decline in prices of petroleum p roducts and gold will
make a favorable contribution to consumer inflation in September. On the
other hand, there might be a temporary increase in in flation in October.
The studies conducted by the Central Bank indicate that e specially the
prices of processed food are likely to display high increase s in the month
of Ramadan. For the current year, it is calculated that the effect of
Ramadan will be quite visible in October inflation. Analyzing the mentioned
effect along with other seasonal factors, it is foreseen t hat inflation is likely
to be realized high temporarily in October.
4. In the recent period, annual price increases in the services group declined,
albeit in a limited manner. The most significant declin e was observed in
transportation services that were mostly affected by the developments in
oil prices. Annual price increases in the rents and the re staurants and
hotels group maintain their high levels by displaying a similar course to
that of the previous year. The annual price increases in these groups are
expected to lose pace in the upcoming period along with the slow down in
domestic demand.
Factors Affecting Inflation
5. The recently released data related to the factors affect ing inflation indicate
that the partial improvement in the inflation outlook has continued. Leading
indicators confirm our earlier conjecture that total dem and would slow
down, albeit not as significantly. The fact that the in dustrial production
displayed a rapid increase in July, while, the amount o f stock of
manufactured goods, one of the Business Tendency Survey ( BTS)
indicators, has risen at the same time indicates that expe ctations
regarding the demand conditions are not very strong. T he decline in the
capacity utilization in the manufacturing industry in Ju ly and August, as
well as the ongoing slowdown in consumer credits and the contraction in
demand for money further support this interpretation.
6. While the upward trend in interest rates reduces the de mand for credits,
weakened risk appetite and contraction in excess liquidity in the market
limit the credit supply. Currently available data on consumer credits and
confidence indices, as well as sales of automobiles and whit e goods,
indicate that there is a decline in demand for commodit y groups, which
have a high degree of pass-through from the exchange r ates to the prices,
such as consumer durables and for sectors that are highly susce ptible to
financing conditions like the housing sector. Meanwhile, t he leading
indicators related to the consumption do not reveal a si gnificant slowdown
in demand for semi-durable and durable goods.
7. While the indicators related to the domestic demand rev eal a notable
slowdown, foreign demand pursues a relatively strong cou rse. The
continuance of the partial rise in productivity and susta ined global
economic activity underpins the rise in exports. The fact that the rise in
exports supports the economic activities turns out to be a factor limiting the
slowdown in total demand.
8. The rate of increase in investments that experienced a sl owdown due to
the changes in financing conditions and the upsurge in th e relative prices
of investments is expected to maintain this trend in the short run. As a
matter of fact, deceleration is noteworthy in the incre ase in machinery-
equipment production, imports of capital goods and dome stic sales of
heavy commercial vehicles along with the production of t he non-metallic
minerals sector, providing intermediate input for the construction sector.
9. Despite these developments, no serious deterioration is o bserved in the
medium- term investment tendency. There has not been a significant
decline in the next twelve month-investment expenditu re tendency, one of
the BTS indicators. Given that demand uncertainty is th e most important
factor restricting investment expenditures, the continuance of the course of
the next twelve month-demand expectations, one of the BTS indicators, in
favor of those that consider the capacity level inadequa te compared to the
expected demand over the next twelve months, indicate that firms
perceive the recent environment of uncertainty as tempo rary and that
expectations for demand in the medium term are not pe ssimistic. The
confidence in the economy resulting from the sustained bu dget discipline
and strong course of the long-term credit inflows and th e direct capital
investments are all considered to be the factors that rest rain further
deterioration in investment tendency.
10. Rapid increase in productivity of the manufacturing ind ustry and the
resulting decline observed in unit labor costs, continued in the second
quarter of the year as well. As for the third quarte r, no significant change
is expected in employment in this sector; however the in crease in
productivity is forecasted to maintain its high level de spite the slight
decline compared to the second quarter. In this context, productivity
increases are expected to continue in the third quarter of the year as well.
11. The increases in relative labor productivity mainly stem s from capital
deepening parallel to the strong course of investments i n recent years. In
this framework, the continuation of reforms for the imp rovement of the
investment environment bears critical importance for the increase in
productivity and competitiveness, thereby achieving long -term lasting
gains in fighting against inflation.
12. Wage increases in the overall economy stand as another sig nificant
development in terms of the medium-term tendency of t otal demand and
unit costs. The Committee has evaluated the arrangement s in civil
servants’ wages for the year 2007 in light of the medi um-term inflation
outlook and reached the conclusion that the impact of thi s development on
inflation expectations and other wage arrangements shou ld be monitored
carefully.
13. Along with this outlook regarding the labor costs, the e asing of oil and
other commodity prices provides positive signals for the continuation of the
disinflation process as well. The possibility that the wor ld economy may
decelerate gives the impression that the rapid increases i n commodity
prices may stagnate. The developments in oil prices are e specially
significant in terms of restraining the secondary effects o f energy costs,
which have been increasing for a long time.
14. In conclusion, when the overall supply and demand indica tors are
evaluated together, it can be claimed that there is an improvement in the
medium-term inflation outlook to some extent, owing t o both the slowdown
in total demand and the easing of real marginal costs.
15. The improvement in medium-term inflation expectatio ns has continued in
September. In general, the belief in the sustainabili ty of the disinflation
process persists. However, the fact that medium-term infla tion
expectations are significantly above the targets emerges as a risk factor in
terms of wage and price setting. In particular, the ong oing high course of
inflation expectations for the next two years is consider ed as a factor that
should be monitored carefully.
16. International liquidity conditions, which changed due t o the flight to quality
effect in May and June, and increased risk perception, tri ggered the
monetary tightening process in emerging market economies. Recent
analyses indicate that the risk of an unexpectedly rapid slowdown in the
US economy in the medium term should not be ignored. In case such a
risk materializes, the risk perception will increase in the short term and
fluctuations may be observed in the financial markets. Ho wever, since the
foreign demand will significantly decline in the mediu m term in such an
environment, the monetary tightening process in developing countries may
stop or even reverse.
Monetary Policy
17. Within the context of these evaluations, the Committee decided to keep
the policy rates at its current level. Despite the slight ly more favorable
inflation outlook, it is crucial to preserve the prudent stance in the medium
term perspective since the medium-term inflation expecta tions have not
yet reached to the levels consistent with the targets and the uncertainties
regarding both commodity prices and international liqu idity conditions
continue. The Committee believes that maintaining the cautious stance is
essential for the inflation rate to converge to the ta rgets at the end of the
year 2007. Under such a policy perspective, the decline i n inflation is
expected to be more apparent in the second quarter of 2007 and the
inflation is expected to converge to the targets in the medium-term.
18. In the event of unfavorable developments, which might adversely affect
the medium-term inflation outlook, the Central Bank w ill not hesitate to opt
for further tightening. The Committee defines furthe r tightening in two
a. In case of a development that might cause inflation to display long-
lasting deviations from the targets, the MPC might, in line with the
general framework of inflation targeting, change the policy rates.
Although there was some improvement in the inflation outlook recently,
the Committee considers it too early to rule out the p ossibility of further
tightening.
b. If an unexpected sudden and major fluctuation occurs i n the financial
markets before the next MPC meeting that does not compl y with the
economic principles short-term interest rates in the seconda ry markets
could be allowed to materialize above 17.50, within the 17.50-21.50
19. The Central Bank does not have the leverage to ease th e uncertainties
regarding global imbalances. However, it seems possible t o ease the
operational uncertainties related to the interest rate s resulting from the
current liquidity conditions in the market. Within this framework, the
Committee considers it beneficial to share with the publ ic the foresight that
short-term interest rates will be realized at levels clo se to the borrowing
rates of the Central Bank in the upcoming months. Consid ering both the
evident slowdown in the demand for money and the Tre asury’s borrowing
program, it seems highly possible that the excess liquidit y in the markets
will continue. Thus, it is predicted that the o/n inter est rates in the money
markets will stay close to the borrowing rates of the Cen tral Bank. In other
words, the Central Bank, in principle, will not adhere to the mechanism
outlined in paragraph 18, article (b).
20. The uncertainties related to the global economy will m ost probably remain
on the agenda in the upcoming period as well. It shoul d be kept in mind
that every step taken towards permanent macroeconomic stab ility would
help the economy to overcome the adverse changes in the international
conjuncture at minimum cost. In this context, the continua tion of the
European Union accession process and the uninterrupted imp lementation
of the structural reforms envisaged in the economic progr am as planned
are crucial. Moreover, strict adherence to the budget li mits without
resorting to adjustments in public prices and taxes is criti cal for achieving
medium-term targets.