In this interview, we speak with Santa Zvaigzne-Sproge, CFA, Head of Investment Advice Department at Conotoxia Ltd., to gain insights into Turkey's current inflation situation and the effectiveness of the central bank's monetary policy. Turkey has experienced a significant drop in inflation since Ms. Hafize Gaye Erkan took over as the central bank's governor. However, recent CPI and PPI readings indicate that the battle against inflation is far from over.

Inflation in Turkey has decreased from a staggering 85.51% in October 2022 to 38.21% in June 2023. Nevertheless, the latest data for July, with PPI at 44.50% and CPI at 47.83%, suggests that inflation remains a pressing concern. The Central Bank of the Republic of Turkey has responded to this challenge by raising interest rates from 8.5% to 17.5%, but questions remain about whether these measures will be sufficient to bring inflation to a single-digit level.

FXMAG.COM:

What is your assessment of the CPI and PPI readings from Turkey, and do they allow the central bank to continue too loose a monetary policy? Does Turkey have any chance at all of returning to its inflation target?

Santa Zvaigzne-Sproge, CFA, Head of Investment Advice Department at Conotoxia Ltd.

The Central Bank of the Republic of Turkey has already gone a long way since Ms. Hafize Gaye Erkan was appointed as the central bank’s new governor. Previously, Turkey’s monetary policy was known to be ultra-accommodative, which provoked inflation that may be hard to imagine in the Western world.

Turkey’s inflation plunged more than two times from 85.51% in October 2022 to 38.21% in June 2023, however, the July data of 44.50% for PPI and 47.83% for CPI show that the fight against inflation is certainly not over. After the new governor was appointed, the Central Bank of the Republic of Turkey doubled the key interest rates from 8.5% to 15% and later increased it to 17.5%. While the jump has been rather significant, the interest rates may still be too low to return the inflation to at least one-digit numbers. However, the Central Bank of the Republic of Turkey has expressed that the country’s monetary policy would be further tightened as much as necessary in a timely and gradual manner.

Reasons for such an uptick in last month’s inflation may be at least partially related to the government raising taxes in July on fuel and a variety of goods to repair the deteriorated public finances due to the costly presidential re-election campaign and financing needs to recover from the February earthquakes. Governor Hafize Gaye Erkan has announced that inflation may reach 58% by the end of this year (more than doubling the previous forecast) acknowledging that the process of driving down the inflation may take more time than previously expected.

It is important to note that driving inflation down is a complicated and time-consuming process, and none of the Western countries have succeeded in reaching their 2% target yet despite aggressive rate hike cycles and considerably lower “starting points” (the highest CPI in the US was 9.1% versus Turkey’s 85.51%).

Furthermore, while the commonly accepted target for inflation is 2%, Turkish inflation has not reached this level since 1969. During the relatively low period of inflation in Turkey (2004 – 2018) CPI varied mainly from 6% to 8%. Therefore, these numbers could be more realistic inflation targets for Turkey.

In order for Turkey to successfully return to one-digit inflation, its first task would be to stop its currency from depreciating further. Turkish Lira has lost nearly 45% of its value against the US Dollar (USDTRY = 26.9684) this year. For it to happen, Turkey would need to return the investors’ trust in its currency which may not be an easy task to accomplish. However, interest rates have historically proved to be the most effective and easiest-to-control instrument for policymakers to drive down inflation. Therefore, there may be a high chance of further rate hikes in Turkey’s future