The 'critical' statement in the open letter sent from the Central Bank to the government

The Central Bank has sent an open letter to the government. In a post on the bank's social media account X regarding the letter, it was stated: "An open letter sent to the Government in order to fulfill the accountability responsibility within the scope of Article 42 of the Central Bank Law."

2023 INFLATION

The letter, signed by Central Bank Governor Fatih Karahan and Deputy Governors Cevdet Akçay and Hatice Karahan, was sent to Minister of Treasury and Finance Mehmet Şimşek and addressed the 2023 inflation. The letter pointed out that the coordination of monetary and fiscal policies is of great importance during the disinflation process.

The CBRT emphasized that updating the minimum wage once a year, observing the inflation forecasts in the MTP (Medium-Term Program) for administered/directed prices, wage and tax adjustments, and supporting the tight stance in monetary policy with prudent fiscal policy are of critical importance for establishing the projected disinflation path.

In the open letter sent by the CBRT to the government in accordance with the law, it was stated that the tight monetary policy stance will be maintained until a significant and permanent decline in the underlying trend of monthly inflation is achieved and inflation expectations converge to the projected forecast range. The letter stated that if a significant and permanent deterioration in the inflation outlook is foreseen, the monetary policy stance will be tightened.

THE FOLLOWING INFORMATION WAS SHARED IN THE CENTRAL BANK'S LETTER

"In accordance with Article 42 of the Central Bank Law No. 1211, if the inflation target is not met, the Central Bank of the Republic of Türkiye (CBRT) is required to notify the Government in writing of the reasons for the deviation from the target and the measures to be taken, and to announce this to the public. The 2023 inflation has significantly exceeded the uncertainty range set around the target.

This text explains the reasons for the deviation of inflation from the target and the measures taken and to be taken to reach the target.

Along with this document, the first 'Inflation Report' of 2024, which includes analyses and evaluations regarding the factors affecting inflation in 2023, and the '2024 Monetary Policy' text, which explains in more detail the monetary policy to be implemented to reach the inflation target in the short and medium term, are presented for your information in the annex.

"THESE DEVELOPMENTS HAVE LAID THE GROUNDWORK FOR INFLATION TO INCREASE IN THE SECOND HALF"

Annual consumer inflation, which was 64.3 percent at the end of 2022, declined in the first half of 2023 due to base effects, as well as the horizontal course in the exchange rate, falling foreign currency-denominated import prices, and the impact of energy subsidies.

Thus, annual inflation was 38.2 percent in June. On the other hand, high-rate increases observed in credit growth due to the impact of monetary conditions, wage updates, and transfers made to households made the impact of demand-side factors on inflation significant in the first half of the year. These developments caused the current account deficit to rise through gold and consumer goods imports with the motive of protection against inflation and increased uncertainty in financial markets.

In addition, the supply-demand imbalances created by the Kahramanmaraş-centered earthquakes in February in the goods, services, and labor markets, especially in the housing market, and the short- and medium-term effects of reconstruction activities on public finance increased the pressures on inflation. These developments negatively affected pricing behaviors and laid the groundwork for inflation, which had declined in the first half of the year, to increase in the second half.

THEY EXPLAINED ONE BY ONE

In June 2023, the Monetary Policy Committee (the Committee) decided to initiate a strong monetary tightening process to establish disinflation as soon as possible, anchor inflation expectations, and bring the deterioration in pricing behaviors under control.

In this context, the policy rate was increased by a total of 34 points in the June-December period, rising from 8.5 percent to 42.5 percent. Simultaneously with monetary tightening, simplification was carried out within the macroprudential framework in a way that would increase the functionality of market mechanisms and strengthen macro-financial stability. Monetary tightening was also supported by selective credit and quantitative tightening steps.

In the third quarter of 2023, the cumulative effects of the persistent strong course in domestic demand, tax adjustments, exchange rate developments, wage increases, rigidity in services inflation, and the sudden rise in crude oil prices were effective in inflation dynamics.

In addition, inflation rose due to the additional deterioration in pricing behaviors caused by all these developments occurring simultaneously in a short period of time. Within the framework of these developments, inflation increased by 23.3 points between June and September, reaching 61.5 percent. 4.7 points of this increase stemmed from developments in fuel prices, excluding the exchange rate effect including taxes; 3.8 points from the rise in the exchange rate; and 2.8 points from tax increases other than fuel.

In this period when wage increases and demand were still quite strong, the additional deterioration in pricing behavior caused by the shocks occurring together had an inflation-increasing effect of 10.0 points. The impact of factors other than these remained limited to a total of 2.0 points.

The first effects of monetary tightening were observed on financial conditions and began to reflect partially on demand conditions as well. In the second half of the year, it was observed that external financing conditions improved significantly, reserves recorded a stable increase, demand conditions began to lose strength in a way that would reflect on the current account deficit, the share of Turkish lira deposits increased, and domestic and foreign demand for Turkish lira assets strengthened and increased. All these developments contributed to the effectiveness of monetary policy.

"THE LAST QUARTER OF THE YEAR INDICATED THAT THE UNDERLYING TREND OF INFLATION HAS SLOWED DOWN"

Looking specifically at the last quarter of the year, annual consumer inflation rose by a limited rate of 3.2 points due to the effects of the monetary tightening process on financial conditions and domestic demand, and a significant 2.4-point portion of this effect stemmed from the upward mechanical effect due to households exceeding the free usage limit with the increase in natural gas consumption.

In this period, the underlying trend of inflation also recorded a decline. Pricing behaviors showed signs of relatively stronger improvement primarily in core goods, especially in durable goods groups. Although services inflation remained rigid, the trend in transportation and catering services inflation, which are more sensitive to demand and cost conditions, also slowed down in the last quarter.

The persistent excessive increases in housing prices gave way to a monthly rise that remained below inflation, and leading indicators pointed to a slowdown in new rental listing price increases. The tracked core, statistical, and model-based indicators indicated that the underlying trend of inflation slowed down throughout the last quarter of the year. Thus, the 2023 year-end inflation was 64.8 percent, close to the midpoint of the forecast range shared in the last Inflation Report of the year.

The last quarter developments revealed that there was a gradual withdrawal in the factors affecting inflation due to monetary tightening. In this period, external financing conditions, the strengthening in reserves, the improvement in the current account balance, and the demand for Turkish lira assets contributed to exchange rate stability and the effectiveness of monetary policy. As of the end of 2023, the share of Turkish lira deposits rose from the 32 percent level it had fallen to during the year to over 42 percent, the annual growth of consumer loans fell from its peak of 60 percent to below 40 percent, and the annual growth of 12-month cumulative gold and consumer goods imports fell from its peak of 125 percent to 53 percent.

Entering 2024, the Committee raised the policy rate to 45 percent at the January meeting, and kept it constant in February, taking into account the lagged effects of monetary tightening and other policy steps supporting monetary transmission. By March, the underlying trend of monthly inflation was higher than expected, and indicators regarding the recent period pointed to the continuation of a resilient course in domestic demand. In this context, considering the deterioration in the inflation outlook, the Committee raised the policy rate to 50 percent at the March meeting.

In addition, by making a change in the operational framework, the Central Bank decided that the overnight borrowing and lending rates would be determined with a margin of +/- 300 basis points compared to the one-week repo auction interest rate. The change in the operational framework is a technical correction made considering the high level of interest rates, and the one-week repo auction interest rate will continue to be used as the main policy rate.

"IT IS FORECASTED THAT DISINFLATION WILL BE ESTABLISHED IN THE SECOND HALF OF 2024"

The CBRT will maintain its tight monetary policy stance until a significant and permanent decline in the underlying trend of monthly inflation is achieved and inflation expectations converge to the projected forecast range. If a significant and permanent deterioration in the inflation outlook is foreseen, the monetary policy stance will be tightened.

It is forecasted that the determined stance in monetary policy will reduce the underlying trend of monthly inflation through balancing in domestic demand, real appreciation in the Turkish lira, and improvement in inflation expectations, and will establish disinflation in the second half of 2024.

The CBRT's main goal and priority is to ensure price stability. Monetary policy will be formulated in line with this goal. The one-week repo auction interest rate will continue to be the policy interest rate, and if there are developments other than those foreseen in credit growth and deposit interest, policy steps that will support the monetary transmission mechanism will continue to be taken. As stated in the 2024 Monetary Policy text, the indicators expected to guide economic units regarding the future course of inflation are inflation forecasts in the short term and the inflation target in the medium term.

In this context, monetary policy will continue to be determined in a way that will provide the monetary and financial conditions that will reduce inflation and reach the 5 percent target in the medium term. With the maintenance of the monetary stance, it is forecasted that inflation will be 36 percent at the end of 2024, 14 percent at the end of 2025, and after falling to 9 percent at the end of 2026, it will stabilize at the 5 percent level. Rigidity in services inflation, inflation expectations, geopolitical risks, and food prices keep the risks on inflation alive.

THE STRIKING MINIMUM WAGE DETAIL

The coordination of monetary and fiscal policies is of great importance in the disinflation process, and the assumptions regarding public policies, which have been concretized with the Medium-Term Program (MTP, 2024-2026) that provides for increased predictability, have been reflected in the CBRT's inflation forecasts.

In this context, updating the minimum wage once a year, observing the inflation forecasts presented in the MTP for administered/directed prices and wage and tax adjustments, and supporting the tight stance in monetary policy with prudent fiscal policy are of critical importance for establishing the projected disinflation path.

Other measures announced within the scope of the MTP that support price stability and financial stability are also expected to contribute to the disinflation process. Adhering to the medium-term targets announced in the MTP in a way that is compatible with the disinflation path will play a critical role in establishing price stability. On the other hand, continuing structural reforms that will reduce rigidity and volatility in inflation and supporting technological and digital transformation that will develop supply capacity will contribute positively to price stability and therefore to social welfare in the medium and long term.

In this context, the CBRT will continue its efforts to analyze structural factors, develop relevant policy recommendations, and raise awareness among relevant stakeholders and the public regarding the importance of the fight against inflation."

News Source: 12punto