In this context since 2007, when  2  BIS Review 3/2009  supply shocks became more apparent, the Central Bank has highlighted core inflation indicators excluding energy and food prices and has frequently referred to them. It was emphasized in this period that, despite the upward trend of inflation, there was no pressure on core inflation indicators and that prices, which were not directly affected by supply shocks, did not display high increases. Under the assumption that the hike in energy and food prices is temporary, and thus inflation shall resume its downward trend, the aim was to direct the focus of economic agents to the medium-term in order to avoid undesired fluctuations in economic activity. At first, this approach was successful in containing inflation expectations. However, the fact that shocks were more persistent than expected caused the rise in food and energy prices to influence prices in general and an increase was observed in core inflation indicators. In early 2008, when turbulence in the global markets that started in summer 2007 was combined with domestic political uncertainties, significant depreciation was observed in the Turkish Lira and it became considerably difficult to push inflation expectations down to levels consistent with the previously set inflation target of 4 percent. Although not attaining inflation targets stems from factors beyond the domain of monetary policy, overshooting of inflation target for two consecutive years and also the expectation of overshooting 2008 target have undermined the role of inflation targets as an anchor for inflation expectations.

These shocks, of which some have prolonged impacts, caused inflation to exceed the targets during this period (Chart 1). Chart 1. Inflation developments in Turkey between 2002-2008  (*) November inflation rate was used for 2008. Source: TURKSTAT and CBT. BIS Review 3/2009  1  The first serious shock to the inflation-targeting regime in Turkey arose upon a time when international capital conditions changed to the disadvantage of developing countries and capital outflow was experienced in many countries including Turkey, from May 2006 onwards. In this period, depreciation of the New Turkish Lira (TRY) around 30 percent and the lack of confidence created by financial turbulence combined with sharp increases in food prices due to drought led inflation rates increase and inflation expectations exceed the targets considerably. In order to avoid any permanent effect on pricing behaviors, the Central Bank tightened monetary policy significantly and took a series of additional policy measures. These measures varied from suspending foreign exchange buying auctions to several arrangements regarding TRY and foreign exchange liquidity. Even though the gap between inflation expectations and inflation targets widened following fluctuations, inflation and inflation expectations were to a great extent brought under control, owing to the measures taken. In the period covering 2007 and onwards, the main factors impeding the disinflation process were sharp increases in oil and other commodity prices in the international markets along with adjustments in administered/directed prices.