Durmuş Yilmaz: Press conference for the presentation of the Inflation
Report
Speech by Mr Durmuş Yilmaz, Governor of the Central Bank of the Republic of Turkey, at
the press conference presenting the third issue of the Inflation Report, Central Bank of the
Republic of Turkey, Ankara, 28 July 2008.
* * *
Distinguished Guests and Members of the Press,
Welcome to the press conference for the presentation of the third issue of the 2008 Inflation
Report, one of the most important communication tools of the full-fledged inflation-targeting
regime that we have been implementing.
In this conference, I would like to give you a short summary of our evaluations and the
Central Bank's inflation forecasts in the Inflation Report which will be posted on our website
later today.
1. Inflation developments
Esteemed Members of the Press,
I would like to start with a general assessment of inflation developments in the previous
period and share with you the factors impeding the disinflation process in the first half of the
year.
Distinguished Guests,
In April, both the Open Letter and the Inflation Report issued by the Central Bank of Turkey
presented a detailed explanation for the factors impeding the disinflation process. The source
of inflation has not changed in the past quarter. In the second quarter of 2008, prolonged
increases in food, energy and other commodity prices continued to exert significant upward
pressures on headline inflation. As a consequence 6.8 percentage points of the 10.61
percent annual CPI inflation in July resulted from the direct impact of the rise in food and
energy prices (Figure 1).
Figure 1: Contribution to Annual CPI Inflation
12
Core Goods Services
Food and Energy* Tobacco and Gold**
10
8
6
4
2
0
01.07 02.07 03.07 04.07 05.07 06.07 07.07 08.07 09.07 10.07 11.07 12.07 01.08 02.08 03.08 04.08 05.08 06.08
* Food and Energy: Food, non-alcoholic beverages and energy.
** Tobacco and Gold: Alcoholic beverages, tobacco products and gold.
Source: TURKSTAT, CBT.
Food price developments were determinant in inflation in the second quarter of the year.
Although domestic weather conditions turned more favorable in the first half of 2008, lagged
effects of last year's poor harvest and continued elevation in agricultural commodity prices
continued to keep processed food inflation at high levels. As a consequence, processed food
inflation displayed a cumulative increase of 14.2 percent in the first half of the year (Figure
2). At this point, I would like to remind you that the July Inflation Report, soon to be published
on our website, will provide a detailed explanation on the factors driving domestic food
prices.
Figure 2: Processed and Unprocessed Food Prices
(Annual Percentage Change)
Processed Food
25
Unprocessed Food
20
15
10
5
0
06.07 07.07 08.07 09.07 10.07 11.07 12.07 01.08 02.08 03.08 04.08 05.08 06.08
Source: TURKSTAT, CBT.
Developments in energy prices have been the other major factor driving inflation in the
second quarter (Figure 3). Soaring oil prices continued to lead to significant hikes in the
prices of domestic fuel products, also putting pressure on housing utilities such as electricity
and natural gas.
Figure 3: Energy Prices
(Quarterly Percentage Change, Percentage Point Contribution)
10
Fuel (Percentage point contribution)
Energy for housing (Percentage point contribution)
8
Energy (3-Month percentage change)
6
4
2
0
-2
07-I 08-I
06-II 07-II 08-II
06-III 07-III
06-IV 07-IV
Source: TURKSTAT, CBT.
Services inflation displayed a limited rise in the first half of 2008. Food and energy prices
continued to exert upward pressures on the prices of catering and transport services. Rents
and other services, on the other hand, continued to decelerate (Figure 4).
Figure 4: Subcomponents of Services Index
(First Half Cumulative Percentage Change)
12
2006-2007 Average
2008
10
8
6
4
2
0
Services Rent Transport Restaurants Other
Services and Hotels Services
Source: TURKSTAT, CBT.
In the second quarter of 2008, core inflation indicators also showed an upward trend. The
rise in core inflation in the second quarter should be viewed as a temporary movement
arising from the exchange rate pass-through, rather than deterioration in the general price
setting behavior. Ongoing difficulties in global credit markets coupled with domestic
uncertainties have led to a depreciation of Turkish Lira vis-à-vis major currencies in the first
four months of the year. As a consequence, first round effects of exchange rate pass-through
have been significant on the headline inflation as well as on core inflation figures during the
March-May period. Yet, the recent rebound in Turkish lira and weakening domestic demand
has limited the overall pass-through and consequently core inflation showed signs of easing
in June. Currently, annual rate of increase in CPI excluding food, energy, tobacco and gold
items stands at 6.4 percent, confirming that the inflation can be mostly attributed to factors
beyond the control of the Central Bank of Turkey (Figure 5).
Figure 5: Main Inflation Indicators and Policy Rates
18 18
16 16
14 14
Policy Rate
H
12 12
I
10 10
8 8
6 6
4 4
12.05 03.06 06.06 09.06 12.06 03.07 06.07 09.07 12.07 03.08 06.08
H: CPI excluding unprocessed food, energy, alcoholic beverages, tobacco, and
gold.
I: H excluding processed food.
Source: TURKSTAT, CBT
The rise in inflation rates stands out to be an ongoing global trend. Elevated commodity
prices have continued to exert inflationary pressures all over the world. As depicted in the
slide, almost all emerging economies under inflation targeting have faced significant
breaches in their inflation targets (Figure 6).
Figure 6: Inflation and Target Bands in Emerging Economies
(as of May 2008)
16
14
Inflation Target Band
12
10
8
6
4
2
0
Rica
Peru
Chile
Israel Brazil
Africa
Korea
Poland Turkey
Mexico Iceland
Hungary
Republic Republic
Romania
Colombia
Philippines
Costa Guatemala
South
Czech
Slovak
Source: Web sites of central banks, IFS, TURKSTAT, CBT
2. Reaction of monetary policy
Distinguished Guests and Members of the Press,
After making brief remarks on the inflation developments in the previous period, in this part of
my speech, I would like to touch on the policies carried out by the Central Bank during this
process.
In the April Inflation Report and the open letter dated April 2008, we indicated that
uncertainties in the global economy, hikes in energy prices, and the risks to price setting
behavior compelled the monetary policy to be more responsive to the incoming information.
In this framework, they revealed a clear tightening bias against increased risk related to the
second round effects of the supply side shocks. Food and energy prices continued to rise in
the second quarter of 2008 and financial markets remained under stress. In the meantime
domestic uncertainties have intensified, having further adverse impact on the medium term
inflation expectations. Accordingly, there has been a significant upward surge in the medium
term inflation expectations in the second quarter of 2008 (Figure 7).
Figure 7: Inflation Expectations*
9
12 Months 24 Months
8
7
6
5
4
07.05 09.05 11.05 01.06 03.06 05.06 07.06 09.06 11.06 01.07 03.07 05.07 07.07 09.07 11.07 01.08 03.08 05.08 07.08
*24 months expectations is available from May 2006 onwards.
Source: CBT.
In order to contain the deterioration in inflation expectations and to prevent the
materialization of the second round effects of supply-side shocks, the Monetary Policy
Committee tightened monetary policy in the past three months, increasing the policy rates by
a cumulative of 150 basis points (Table 1). In current conjuncture, where the consumption
demand keeps slowing down, I would particularly like to emphasize that the monetary
tightening policy was adopted in order to halt the deterioration in inflation expectations and
the upsurge in the risk premium. As a consequence, the deterioration in inflation
expectations ceased and market rates declined in July (Figure 7). In other words, the
monetary tightening policy conducted by the CBT contributed to the decline in medium and
long-term interest rates by diminishing the inflation risk premium.
At this point, I would like to underline an operational aspect of monetary policy relating to
policy rates. In the first half of 2008, excess liquidity sterilized in the overnight market shrank
due to the cut in the volume of daily FX-buying auction as well as the Treasury's less FX
borrowing and the rise in money demand. These developments led to occasional liquidity
shortages. By May 2008, liquidity shortage has started to emerge more often for longer
periods. During this period, the Central Bank provided the required liquidity into the system
via one-week repo auctions, targeting overnight interest rates to materialize at levels close to
Central Bank borrowing rate. Still, there has been some undesired volatility in the overnight
rates due to unforeseen movements in the liquidity, mainly arising from the banks' demand
for reserves. Considering these developments, the Monetary Policy Committee has decided
to reduce the margin between the borrowing and the lending rates by 50 basis points in July.
Current projections do not point to a permanent shortage in the liquidity in the upcoming
term. In case of temporary shortage, the Central Bank will provide the required liquidity
through one-week repo auctions, targeting the overnight interest rate in the money market to
stay close to the Central Bank borrowing rate. Hence, the key policy rate will continue to be
Central Bank's overnight borrowing rate.
Table 1: Monetary Policy Committee (MPC) Decisions in 2007 and 2008
Dates for MPC Meetings Decision on Interest Interest Rate
Rates
January 16th, 2007 No Change 17.50
February 15th, 2007 No Change 17.50
March 15th, 2007 No Change 17.50
April 18th, 2007 No Change 17.50
May 14th, 2007 No Change 17.50
June 14th, 2007 No Change 17.50
July 12th, 2007 No Change 17.50
August 14th, 2007 No Change 17.50
September 13th, 2007 -0.25 17.25
October 16th, 2007 -0.50 16.75
November 14th, 2007 -0.50 16.25
December 13th, 2007 -0.50 15.75
January 17th, 2008 -0.25 15.50
February 14th, 2008 -0.25 15.25
March 19th, 2008 No Change 15.25
April 17th, 2008 No Change 15.25
May 16th, 2008 +0.50 15.75
June 17th, 2008 +0.50 16.25
July 18th, 2008 +0.50 16.75
Source: CBT.
3. Inflation outlook and monetary policy
Distinguished Guests,
After summarizing the developments in the previous period, in this part of my speech, I would
like to share with you our projections about the inflation and the monetary policy in the
upcoming period and the seasonally adjusted inflation forecasts of the Central Bank.
Recent readings on supply and demand conditions are in line with the outlook presented in
our April Inflation Report and the open letter of April 2008. Although first quarter private
consumption growth at 7.3 percent appears quite strong in annual terms, the seasonally
adjusted figures point to an ongoing moderation in economic activity (Figure 8). Recent
readings on domestic sales, production and confidence indicators suggest a similar outlook.
At this point, I would like to remind you that the indicators regarding the course of domestic
demand are presented in detail in the July Inflation Report.
Figure 8: Private Consumption
(Seasonally Adjusted, Billions, YTL)
19
18
17
16
15
14
13
12
03Q1 03Q3 04Q1 04Q3 05Q1 05Q3 06Q1 06Q3 07Q1 07Q3 08Q1
Source: TURKSTAT, CBT.
Data on consumer credits suggest that monetary conditions continue to be restrictive.
Consumer loans have been growing at a moderate pace compared to the periods of vigorous
domestic demand (Figure 9). The decline in risk appetite and the tightening in global credit
conditions are likely to restrain credit expansion in the period ahead.
Figure 9: Consumer Loan Growth Rate
(Q-on-Q, in real terms)
80
Housing
Automobile
60
Other
40
20
0
-20
03.05 06.05 09.05 12.05 03.06 06.06 09.06 12.06 03.07 06.07 09.07 12.07 03.08 06.08
Source: TURKSTAT, CBT.
Overall, domestic demand conditions continue to support disinflation (Figure 10). Therefore,
the underlying inflation is expected to decelerate in the medium term.
Figure 10: Output Gap
8
6
4
2
0
-2
-4
-6
-8
-10
00Q1 00Q3 01Q1 01Q3 02Q1 02Q3 03Q1 03Q3 04Q1 04Q3 05Q1 05Q3 06Q1 06Q3 07Q1 07Q3 08Q1
Source: CBT.
Dear Guests,
After the significant weakening of the Turkish lira in the first four months of 2008 (Figure 11),
exchange rates have reversed direction in the past two months, easing to some extent
potential pressures on tradable inflation resulting from the exchange rate pass-through. In
the April Inflation Report and the Open Letter, the first round impact of the recent
depreciation was estimated to be close to 2-percentage points for the end-2008 headline
inflation. The recent rebound in currency has led to a downward revision in the estimated
pass-through. We now anticipate a cumulative exchange pass-through of around 1.2 percent
points for 2008, most of which has already been materialized between March-May period.
Figure 11: Risk Premium and Nominal Exchange Rates
2 450
YTL/Currency Basket (0.5 Euro+0.5 US Dollar)
400
1,9
EMBI+Turkey (right axis)
350
1,8
300
1,7
250
1,6
200
1,5
150
1,4
100
1,3
50
1,2 0
11.06 01.07 03.07 05.07 07.07 09.07 11.07 01.08 03.08 05.08 07.08
Source: CBT.
Longer-term interest rates have also increased in 2008 due to rising risk premium and
inflation expectations (Figure 12). Although higher market interest rates contain the domestic
demand and support disinflation, the impact of the heightened risk premium on the overall
pricing behavior should be closely monitored.
Figure 12: Benchmark Interest Rate and Policy Rate
24
22
20
18
16
14
Benchmark Interest Rate
12
Policy Rate
10
01.06 04.06 07.06 10.06 01.07 04.07 07.07 10.07 01.08 04.08 07.08
Source: CBT, ISE.
Baseline assumptions in the April Inflation Report envisaged a constant path for oil prices
around 105 USD per barrel over the forecast horizon. However, oil prices continued to rise
on the back of increasing international commodity prices, necessitating an upward revision
(Figure 13). Taking the average future prices in the first three weeks of July as a benchmark,
our baseline scenario for oil prices has been revised to USD 140 per barrel. As for the future
adjustments in electricity tariffs - to be made within the scope of automatic pricing -, they are
forecasted to be in compliance with the assumption for the oil price. This revision has
increased the end-2008 inflation forecast by 1.8 percentage points, and also added to the
end-2009 forecasts 0.6 percentage points.
Figure 13: Crude Oil (Brent)
(USD/Barrel)
150
Crude Oil
130
110
90
70
50
01.07 03.07 05.07 07.07 09.07 11.07 01.08 03.08 05.08 07.08
Members of the Press and Dear Guests,
Our revised forecasts envisage slightly higher food inflation in 2008 and 2009 compared to
the April Inflation Report. Although unprocessed food prices followed a relatively favorable
course, processed food inflation is likely to stay at high levels for while, given the elevated
course of agricultural commodity prices. Against this backdrop, we have raised the
assumptions for food inflation from 13 percent to 14 percent for the year 2008, and from 8
percent to 9 percent for the year 2009. These changes have led to an upward revision in our
inflation forecasts by about 30 basis points, for both 2008 and 2009. The projections
envisage gradually moderating food inflation throughout the forecast horizon. In this context,
assumption for 2010 food inflation is 7 percent.
According to the framework drawn so far, we now forecast inflation to be around 10.6 percent
at the end of 2008. Under the assumption of a limited tightening towards the end of 2008, our
medium term forecasts suggest that, with 70 percent probability, inflation will be between 5.9
and 9.3 percent (mid-point 7.6) at the end of 2009, and between 4 percent and 7.8 percent
(mid-point 5.9) at the end of 2010 (Figure 14). Our inflation forecast for mid-2011 is 5.4
percent. We expect non-food inflation to be lower than these figures.
Figure 14: Inflation Forecasts*
Forecast Range* Output Gap
Uncertainty Band for 2008 End-Year Inflation Targets
12
Control Horizon
10
8
6
4
Percent
2
0
-2
-4
-6
2008- 2009- 2010-
2008-I 2009-I 2010-I 2011-I
2008-II 2009-II 2010-II 2011-II
2008-III 2009-III 2010-III
Source: CBT
* The shaded region indicates the 70 percent confidence interval for the forecast.
To sum up, although economic activity in the past quarter have evolved in line with our
expectations, the significant increases in oil and processed food prices have led to an
upward revision in our forecasts. The main message of the forecast is that preventing the
materialization of potential second round effects and ensuring a steady decline in inflation
towards the medium term targets, requires the monetary policy to maintain a cautious stance
for a while.
Therefore, the path for the policy rates indicated above should not be perceived as a
commitment on behalf of the CBT. I would like to once more emphasize that any new data or
information regarding the inflation outlook may lead to a change in our policy stance.
4. Risks and monetary policy
Distinguished Guests,
I would like to dedicate the last part of my speech to the upside and downside risks to
inflation and monetary policy in the upcoming period.
Uncertainties about food and energy prices still continue. Our baseline scenario is based on
quite conservative assumptions for food and energy prices, implying that downside risks on
these factors are as apparent as upside risks. In order to enhance the predictability of the
monetary policy, in a period when uncertainties pertaining to oil and agricultural commodity
prices continue, we deem it to be useful to share with the public the inflation and monetary
policy outlook, which is based on alternative scenarios for food and energy prices.
In our pessimistic scenario, we assume that food price inflation materializes at 16, 12 and 10
percent in 2008, 2009 and 2010 respectively; whereas oil prices rise to USD 180 at the end
of 2008, staying constant thereafter. Additionally, adjustments in electricity tariffs are
forecasted to be made in compliance with this assumption. Assuming a gradual monetary
tightening during the rest of the year, our forecasts under this scenario suggest that inflation
will be 9.1 percent at the end of 2009 and around 7 percent at the end of 2010 (Figure 15).
In our optimistic scenario, we assume that food price inflation materializes at 12, 6, and 4
percent respectively, in the 2008-2010 period, whereas oil prices ease to USD 100 at the end
of 2008, staying constant thereafter. Additionally, adjustments in electricity tariffs are
forecasted to be made in compliance with this assumption. Assuming that policy rate stays
constant for a while and gradually ease thereafter, our forecasts under this scenario suggest
that inflation will be 6.1 percent at the end of 2009 and around 4.9 percent at the end of
2010.
In sum, monetary policy will be conducted so as to minimize upside deviations from the
targets should the upside risks materialize. Downward surprises in food and energy prices,
on the other hand, will be perceived as an opportunity to bring inflation back to target in a
shorter period than envisaged in our baseline scenario.
Figure 15: Inflation Forecasts,
Baseline and Alternative Scenarios
Baseline Senario End-Year Inflation Targets
Pessimistic Senario Optimistic Senario
12
10
8
Percent
6
4
2
2008- 2009- 2010-
2008-I 2009-I 2010-I 2011-I
2008-II 2009-II 2010-II 2011-II
2008-III 2009-III 2010-III
Source: CBT.
Distinguished Guests,
Despite the expected decline in inflation in the medium term, uncertainties exist regarding the
degree of inflation persistence. Long-lasting supply shocks have been keeping headline
inflation at elevated levels and thus increasing the risk of rising backward-looking schemes in
the wage and price setting behavior. Although current demand conditions contain the second
round effects of the supply shocks, the exact pace of disinflation would still depend on the
extent new inflation targets serve as a strong reference for economic agents. Having this in
mind, the CBT will continue to focus on enhancing the credibility of the new inflation targets.
In this context, developments in the general pricing behavior and the underlying inflation
trends will be monitored closely.
International financial markets remain fragile and the credit conditions continue to tighten up.
The eventual impact of the financial turmoil on the global economic activity is yet to be seen.
Moreover, rising commodity prices continue to exert pressure on global inflation. These
uncertainties have been dampening the risk appetite and thus slowing down the capital flows
to emerging markets, leaving these economies susceptible to shifts in the market sentiment.
Domestic uncertainties have exacerbated these effects, as manifested by the significant rise
in the sovereign credit risk of Turkey in the first half of the year, compared to the average risk
premium of emerging economies. The CBT will not display a sharp reaction to temporary
fluctuations in the financial markets, unless there is a threat to the medium-term disinflation
trend and/or a significant worsening in the general pricing behavior.
Finally, I would like to state that our medium-term projections do not foresee any significant
effect to be brought about by the increases in indirect taxes or administered price
adjustments, except those required by the automatic pricing mechanisms. In other words,
should a requirement arises for a tightening in the public budget, we assume that this
requirement will be met by measures for cutting down on expenditures rather than increasing
the indirect taxes. Any deviation from this framework may lead to a revision of the outlook for
inflation and monetary policy.
Distinguished Members of the Press,
A protracted period of rising food and energy prices has been hampering our disinflation
efforts since the adoption of the inflation targeting regime. Ongoing uncertainties resulting
from global as well as domestic factors that led to a significant deterioration in inflation
expectations necessitated a more cautious monetary policy stance. In this respect, in order
to prevent the said uncertainties to be reflected on the general pricing behavior, we have
conducted a monetary tightening over the past three months. Monetary tightening was
effective in containing inflation expectations, as the deterioration in inflation expectations
came to a halt in July.
Current stance of the monetary policy supports disinflation. We expect inflation to remain at
elevated levels in the short term before gradually moderating towards the targets. Our
revised inflation forecasts suggest that the inflation targets of 7.5 percent, 6.5 percent, and
5.5 percent set for the next three years are attainable, even under quite conservative
assumptions on food and energy prices. I would like to underline that adverse impacts of the
supply side shocks on the economy will be more limited should all the economic agents take
these targets as a benchmark in forming their expectations.
Prudent monetary policy is a necessary but not sufficient condition for attaining price stability.
The support from fiscal policy and structural reforms are as critical as the monetary policy in
this respect. Sound fiscal policy has been one of the main factors in driving inflation down to
single digits. The role of fiscal policy will continue to be critical on the road to price stability.
Preserving the resilience of the economy, especially under current conditions, requires the
continuation of fiscal discipline and structural reforms. In this respect, the European Union
accession process and the implementation of structural reforms envisaged in the economic
program remain to be of utmost importance. I would like to conclude my remarks by stating
that advances in structural reforms, which would improve the quality of fiscal discipline and
enhance productivity, are monitored closely by the CBT with regard to their implications on
macroeconomic and price stability. Thank you.