Therefore, it is unlikely for unit labor costs to be subject to cost pressures in coming months. In sum, monetary conditions remained supportive of domestic demand in the fourth quarter. Private demand recovered more rapidly amid increased consumption and investment spending, therefore aggregate demand conditions provided less support for disinflation than suggested in the October Inflation Report. Nevertheless, I would like to emphasize that the recent policy measures are expected to bring domestic demand back on to a more moderate growth path in the upcoming period. Our inflation forecasts are based on the projections of the Medium-Term Program (MTP) as was the October Inflation Report. The use of a large fraction of the additional increases in tax revenues as a result of the stronger-than expected economic activity in the last quarter of 2010 has been the primary driver of the slight upward revision to output gap forecasts. However, as the budget balance remained largely in line with MTP targets, the medium-term fiscal policy outlook was barely changed. Therefore, our forecasts are based on the assumption that the primary expenditure-to-GDP ratio would decline gradually, the debt-toGDP ratio to decline further, and the risk premium to remain broadly unchanged over the forecast horizon. Moreover, I would like to note that we assume tax adjustments to be consistent with inflation targets and automatic pricing mechanisms. Now I would like to brief you about the assumptions underlying our inflation forecasts. The developments since the reporting period of the October Inflation Report urged us to revise our assumptions underlying our forecasts.

Exceptionally loose monetary policies adopted by advanced economies to eliminate the downside risks on economic activity not only boosted global liquidity but also stimulated the search for yield, which encouraged more capital flows into emerging economies. Moreover, the weak recovery in developed economies – Turkey’s main export destinations, dampened foreign demand growth (Figure 2). Low interest rates across the globe, soaring imports driven by strong credit growth amid increased short-term capital inflows, and weaker foreign demand caused the current account deficit to widen rapidly in 2010. All of these developments prompted the CBRT to adopt a strategy, which partly targets financial stability besides the main objective of price stability, parallel to the conditions referred to as the “new normal”. In this context, as stated previously, the CBRT has actively begun to use tools such as required reserves and liquidity management, in addition to the one-week repo auction rate, the main policy instrument. 1. Inflation developments  Having summarized the global economic conditions and the implications of this outlook on the monetary policy, I would now like to inform you about the inflation developments of the last quarter. As you will recall, we underlined in the October 2010 Inflation Report that the increases in unprocessed food and tobacco prices – which are beyond the immediate control of the CBRT – added about 5 percentage points to annual inflation, and suggested that these items would leave sizable room for disinflation. Indeed, inflation dropped by 2.83 percentage points, yielding a rate of 6.4 percent, meeting the year-end inflation target.