Coupled with the ongoing slowdown in domestic demand, this led to a sustained fall in the annual rate of increase in core goods prices. Meanwhile, prices of services remained on a mild track (Chart 16). Against this backdrop, core inflation indicators maintained a downward trend (Chart 17). Chart 16. Chart 17. Prices of Core Goods and Services  Core Inflation Indicators SCA-H and SCA-I  (Annual Percent Change)  ( Annual Percent Change)  Source: TurkStat. Source: TurkStat. Now, I will touch upon the developments in economic activity on which the inflation forecasts are based besides the short term outlook. Third-quarter national income data point that domestic demand conditions remained weak due to private investment demand. Private consumption, which displayed an increase for the first time in a protracted period, limited the slowdown in final domestic demand. Nevertheless, demand conditions followed a slightly weaker course compared to the projections in the October Inflation Report (Chart 18). Last-quarter data indicate a mild pick-up in consumption and investment demand as envisaged. Accordingly, output gap forecasts regarding the second half of 2012 are slightly revised downwards compared to the previous report. Chart 18. 2012Q3 Final Domestic Demand: Forecast and Realizations (Seasonally Adjusted, 2008Q1=100)  Source: TurkStat, CBRT. Meanwhile, we estimate that easing financial conditions due to the recent rise in capital inflows may result in a higher-than-expected growth in final domestic demand in the first half of 2013. Indicators for orders, loans and other leading indices also support this outlook.

Improved risk appetite and more effective use of the Reserve Options Mechanism (ROM) have allowed a gradual reduction in the upper bound of the interest corridor since September. Meanwhile, the liquidity provided for the market was further increased, driving overnight market rates close to lower bound of the corridor. Chart 7. Policy Rate and Liquidity Policies (Percent)  Source: ISE, CBRT. Capital inflows accelerated at the year-end upon the surge in global risk appetite coupled with a relative improvement in risk perceptions regarding Turkey. This contributed to a fasterthan-expected credit growth and appreciation pressures on the Turkish lira. I suppose you remember that we stated this as a possible risk scenario in the previous Inflation Report and listed possible measures we could take. Upon the materialization of these risks to a large extent, we launched the strategy we envisaged. In order to contain the risks on financial stability, the appropriate policy response would be to keep interest rates at low levels while sustaining macroprudential measures. In this respect, the policy rate and the corridor have recently been shifted down and a measured tightening has been implemented through reserve requirement policy. Despite the cut in short term interest rates, the CBRT maintained its cautious and flexible stance, which is worth noting. Thus, I would like to reiterate that the impact of the measures taken on credit, domestic demand and inflation expectations will be closely monitored and the amount of the Turkish lira funding will be adjusted in either direction, as needed. Chart 8. Chart 9.