Turkey's new central bank chief sticks to policy despite rising inflation forecast

Since Hafize Gaye Erkan took the reins last month, the regulator has raised its key rate by 900 basis points to 17.5%

Turkish Central Bank Governor Hafize Gaye Erkan at a press conference in Ankara, Turkey. EPA
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Turkey’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 on Thursday 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 after years of unconventional measures championed by President Recep Tayyip Erdogan.

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

Alongside declines in the lira and faster increases in food costs, strong domestic demand and wage increases 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 Ms 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 has, so far, been treading carefully in doling out Turkey’s first interest-rate increases in more than two years, an approach she repeatedly had to defend at the presentation in Ankara.

Ms Erkan said the central bank was 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 Mr Erdogan’s influence on the central bank’s policymaking, Ms Erkan stressed the monetary authority was “fully independent”.

Three previous governors who did not 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,” Ms Erkan said.

“During this transition, markets are being stabilised within their own internal dynamics.”

Many analysts were expecting Ms Erkan to unveil a much lower figure, with Bloomberg Economics predicting policymakers would bring their call to a rate in the range of 40 per cent-44 per cent.

The latest projections show Turkey will miss its 5 per cent official price target over a three-year horizon.

Turkey’s inflation soared to near 86 per cent last year as Mr 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 per cent in June, although Ms Erkan said it would be a temporary acceleration.

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

Mr Erdogan won re-election in May, extending his rule into a third decade. His new administration has pledged a shift to more orthodox policies in an attempt to attract the billions of dollars of foreign investment it needs to rebuild Turkey’s reserves as the economy emerges from a cost-of-living crisis.

Since Ms Erkan became governor, the central bank has raised its key rate by 900 basis points to 17.5 per cent.

That is less than many analysts were expecting and leaves Turkey’s benchmark firmly in negative territory when adjusted for prices.

Ms Erkan said credit-tightening measures support the increases 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 per cent in the second quarter of next year, Ms Erkan said it was important to recognise the broader implications of the rate increases, including on the banking and real sectors.

“Our inflation expectations include our policy reaction and accumulated impact,” Ms Erkan said.

“The monetary policy’s aim is to lower the underlying trend in inflation.”

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

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

Updated: July 28, 2023, 12:12 PM