Yippee, inflation is falling!
Except that it is not! It is true that according to official figures released by the Turkish Statistical Institute on July 3, prices fell 0.5 percent monthly in June, lower than expectations of a 0.2 percent fall. As a result, annual inflation fell almost one percentage point, from 8.1 to 7.2 percent.
However, the plunge was almost entirely due to food prices, which contributed -0.7 percentage points to monthly inflation. According to my calculations, unprocessed food prices fell around 6.5 percent in June, driving annual unprocessed food inflation to single-digit territory from more than 16 percent. Headline food inflation fell from 12.8 to 9.3 percent, its lowest since September 2013.
However, both non-food and core inflation, which excludes the volatile energy, food, beverages, tobacco and gold prices, slightly edged up. The three-month moving average of seasonally-adjusted monthly core inflation, an indicator of trend inflation often used by Turkey economists, stayed put at 0.8 percent - over 9 percent annualized.
Similarly, a cursory look at the prices of some services items such as rent, transportation, restaurants, cafés and hotels reveals that services inflation stayed roughly the same. Last but not the least, despite lower oil prices, annual producer inflation actually rose from 6.5 to 6.7 percent. At least part of this rise may be passed on to consumers in the next couple of months.
The Central Bank will likely play down all this and emphasize the drop in food inflation when it releases its monthly note on price developments early in the week. In fact, headline inflation may fall in July and August as well on the back of a further correction in food prices. Moreover, thanks to a high base effect from last year, we may even see some decline in core inflation.
However, these developments would not change the big picture; High core inflation indicates that, even if exchange rate pass-through seems to have weakened, the weak Turkish Lira is still taking its toll on inflation. Persistent services prices, on the other hand, are hinting at pricing rigidities, which are likely to stick around (no pun intended) as long as inflation expectations remain elevated.
As a result, while I expect inflation to continue to fall for a month or two, it should start picking up again in the fall once oil price base effects kick in - and end the year at 7.5-8 percent, not only significantly above the Central Bank’s 5 percent inflation target, but also higher than the midpoint of their end-year forecast of 6.8 percent - resulting in yet another missed target.
I wonder if Governor Erdem Başçı, who may finally be free of political pressure from President Recep Tayyip Erdoğan, may aggressively seek to reduce inflation once and for all towards the end of his term, which is expiring in April, instead of using the temporary fall in inflation to lower rates. Of course, Erdoğan would certainly not stay put if he calls for early elections.
Similar to Fed Chairman Paul Volcker, who brought down U.S. inflation in the 1980s, that’s how Başçı would end up in economics textbooks, not because of the monetary policies of the last few years, as some have suggested - at least not in a positive way. One can only hope…