New Turkish central banker redraws inflation path but not policy

Turkiye’s new central bank governor delivered a sobering assessment on inflation but pledged to stick with a “gradual” cycle of monetary tightening despite more than doubling the forecast for price gains.

At an event yesterday that marked her public debut, Governor Hafize Gaye Erkan had the task of restoring the credibility of an institution in need of rehabilitation in the eyes of the markets.

Erkan, appointed last month after long stints in the US at Goldman Sachs Group Inc and First Republic Bank, announced the central bank now projects inflation will end this year at 58%, up from her predecessor’s forecast of 22.3%.

Alongside declines in the lira and faster increases in food costs, strong domestic demand and wage hikes are among the reasons the outlook had to shift far higher, according to her presentation.

The extent of the revision sets out the challenge facing Erkan in trying to get a grip on inflation that the International Monetary Fund expects to be the world’s fifth-fastest in 2023. But she’s so far been treading carefully in doling out Turkiye’s first interest-rate hikes in over two years, an approach she repeatedly had to defend at the presentation in Ankara.

Erkan said the central bank is laying the groundwork for the start of sustainable disinflation in 2024, with an improvement in the trend of consumer prices expected in the second quarter of next year.

When asked about the degree of Erdogan’s influence on the central bank’s policymaking, Erkan stressed the monetary authority was “fully independent.” Three previous governors who didn’t toe the line ended up being removed by the president.

“We are in a transition heading toward the disinflation and stabilisation periods we have envisaged,” Erkan said. “During this transition, markets are being stabilised within their own internal dynamics.”

Many analysts were expecting Erkan to unveil a much lower figure, with Bloomberg Economics predicting policymakers would bring their call to a rate in the range of 40%-44%. The latest projections show Turkiye will miss its 5% official price target over a three-year horizon.

Turkiye’s inflation soared to near 86% last year as Erdogan pursued a growth-at-all-costs strategy that included ultra-loose monetary policy. Price growth is set to pick up again after slowing close to 38% in June, though Erkan said it’d be a temporary acceleration.

Bloomberg Economics predicts inflation will quicken to 55% by the end of the year because of the lira’s recent depreciation and increases in taxes and wages.

“The measures, while significant, are still inadequate. Rate hikes have been lower than financial markets had expected and less than the economy needs. Other tools are unlikely to fill the gap and anchor price expectations. The result? Inflation that’s likely to end the year at around 11 times the 5% target,” says Selva Bahar Baziki, economist at Bloomberg.

Since Erkan became governor, the central bank has raised its key rate by 900 basis points to 17.5%. That’s less than many analysts were expecting and leaves Turkiye’s benchmark firmly in negative territory when adjusted for prices.

Erkan said credit tightening measures support the hikes delivered since June, highlighting the narrowing spread between deposit rates and the central bank’s benchmark as the first explicit sign of an impact from her policy pivot.

The steps were needed to cool consumer demand, she said, given that loan growth is still booming. With inflation on a path to peak around 60% in the second quarter of next year, Erkan said it was important to recognise the broader implications of the rate hikes, including on the banking and real sectors.

“Our inflation expectations include our policy reaction and accumulated impact,” Erkan said. “The monetary policy’s aim is to lower the underlying trend in inflation.”

Erkan was “refreshingly open about the challenge from inflation — the message was clear-cut that inflation is rising,” said Timothy Ash, a veteran Turkiye watcher and senior emerging-market sovereign strategist at RBC Bluebay Asset Management.

“But in hiking the inflation forecast to 58%, it also kind of implies a pretty weak response to fighting that inflation and, I would argue, unfortunately an unwillingness to aggressively tighten policy,” Ash said.