Actually, I am convinced it will fall. I am just not convinced that it will fall to around 5 percent, as the Central Bank of Turkey is assuming, at least not by the end of next year. I went over my main arguments at my latest Hurriyet Daily News column I posted here at the blog, but let me elaborate a bit more.
Let me start by explaining what I meant by the “persistence of structural inflation” in the column. That the trend component of inflation is coming down very slowly, as Citi shows in their presentation I refer to in the column.
It is not that the inflation picture is completely bleak. On the contrary, there are several positive developments. For example, service inflation still looks tame, and looking at components of inflation hints that there isn’t much demand pressure.
However, I don’t agree with several of the Central Bank’s assumptions. For one thing, the Bank downplays food inflation, saying that they are temporary supply shocks. However, as Citi Turkey economists have argued some time ago, in countries like Turkey where food makes up a sizable part of the consumption basket, food inflation could deteriorate inflation expectations.
Second, responding to movements in the exchange so strongly runs the the risk of transforming the exchange rate into a nominal anchor for monetary policy that takes precedence over the inflation target. In plain English, the exchange rate could end up being the determinant of inflation expectations, which would, in turn, aggravate the problem by raising the bar to keep the exchange rate stable. Maybe, the Central Bank’s recent statement that they would sell USD50mn/day except under rare circumstances could be because they are aware of this risk.
Finally, the Bank has also been downplaying the exchange rate pass-through for a while. They even published a paper showing that it is around 15 percent. But now after the most recent inflation figures, the Bank has started implying it is a bit larger.
This last point points to a more general problem in the Bank’s communication strategy. As Radikal columnist Ugur Gurses reported in a column a couple of weeks ago (in Turkish), many Turkey economists think that the Bank is massaging numbers and charts so that they will tell a story in line with their arguments. In essence, they are saying that the Bank is trying to “manipulate expectations”, rather than “manage them”. Not good, not good at all… So I hope the improvement in communication strategy Governor Erdem Basci promised today at the 2012 Monetary and FX Strategy meeting will entail much more than holding two of the four Inflation Reports in Istanbul…