Turkey CPI Surprise Masks Data That May Put Chill on Rate Cuts

  • Decline in food costs fuel Turkey rate cut expectations
  • Too deep a cut could backfire if food prices rise again

Turkish President Recep Tayyip Erdogan wants to slash interest rates. Food prices may disappoint him.

Annual headline inflation slowed the most in March in more than three years, largely because food prices dropped. But core inflation, which strips out volatile prices such as food and energy, didn’t improve as much. If the central bank cuts its overnight lending rate deeper this month than it did in March and food prices later turn up, that could threaten gains in inflation and the lira, analysts said.

The limited slowdown in core price gains should restrain policy makers from making “aggressive” rate cuts in their April 20 decision, Odeabank AS economist Sakir Turan said Monday from Istanbul.

Turkey is struggling to contain inflation at a time when its top two leaders are at odds over the direction of monetary policy, an issue crucial to investors because the government relies on foreign-currency flows to plug its current-account deficit. While Erdogan says high borrowing costs have stifled growth, Prime Minister Ahmet Davutoglu wants to contain price gains that have surged beyond the government’s 5 percent target, people familiar with the matter said last month, speaking on condition of anonymity to discuss private conversations.

Limited Core Improvement

A combination of one-time factors make the risk of a surge in food inflation a concrete threat. The chief reason food prices seemed so low in March was that bad weather drove them up so high a year earlier, beyond central bank projections. What’s more, food inflation this year was relatively slow, largely due to a decline in tourism over political turmoil and a government cap on red-meat prices, Turan said.

Lower food prices led inflation to slow to 7.46 percent in March from 8.78 percent a month earlier, beating the median estimate of 8.2 percent in a Bloomberg survey of analysts. Core inflation slowed to 9.51 percent from 9.72 percent.

The most important risk after borrowing costs drop “is inflation not following rates down,” Inan Demir, chief economist at Finansbank, said on Tuesday. “The fact that the steep drop in inflation is mostly driven by the volatile food category keeps the risk of adverse surprises in the coming months firmly on the table.”

Core inflation accelerates quickly at times of lira weakness but doesn’t slow at the same pace when the currency stabilizes, Turan said. The lira lost almost 20 percent against the dollar last year when core inflation climbed to 9.51 percent from 8.73 percent at the end of 2014, according to data compiled by Bloomberg.

Room to Ease

Asli Savranoglu Seren, chief economist at Turkey’s Burgan Securities, predicted the bank would pare as much as 50 basis points. She said a “more cautious stance would be more appropriate” to support recent lira gains and improve the inflation outlook.

Governor Erdem Basci, whose term expires the day before the rate meeting, said last month’s 25-basis-point cut to the overnight lending rate was the first step in his pledge to simplify his three-track rates corridor.

Complicating matters further is the uncertainty over who might succeed Basci if his term isn’t renewed. Erdogan is said to be pushing for a replacement who’ll slice rates. Davutoglu is expected to back someone who’ll see price stability as his chief mandate. Both men have to approve the final decision.

“The risk is that political pressure on the central bank to ease rates will increase and that this would jeopardize the fledgling improvement in inflation dynamics,” said Tatha Ghose, a senior emerging-markets economist at Commerzbank AG in London.


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