Turkey At Risk Of Hyperinflation As CPI Soars To 14-Year High

Turkey’s currency is being battered from all sides at the moment. In October 2017, the Lira fell sharply after both countries suspended bilateral visa processing in the latest US/Turkey diplomatic spat (although this was reversed in early November). Two weeks ago, it fell to a record low of 3.97 to the dollar, prompting the central bank to step in and cut borrowing limits for the banks. Last week we reported how the TRY was selling off on news flow from a trial in which a Turkish banker is accused by the US government of helping Iran to evade US sanctions via oil-for-gold deals. Turkey’s former economy minister, Zafer Caglayan, and two other banking executives have also been charged, albeit in absentia. In a document submitted to the court on 30 October 2017, federal prosecutors argued that evidence introduce at the trial will show that senior Turkish government officials and bankers “were integral to the sanctions evasion scheme”. There is a risk that the trial results in diplomatic penalties against Turkey and its banks and further sours US/Turkish relations.

Meanwhile, Turkey’s already high inflation rate continues to surprise on the upside. Last month, the consensus expectation for the October 2017 headline CPI was 11.5% - instead the number came in at 11.9%. This month, the expectation for November 2017 was 12.5% and the headline CPI printed at 12.98%. This was the highest level since November 2003.

In terms of the breakdown, food and non-alcoholic beverages rose 15.78% from 12.74% in October, transportation 18.56% from 16.79% and housing and utilities 9.81% from 9.40%. On a positive note, inflation at hotels, cafes and restaurants stabilised at 10.46% from 10.48%, which undoubtedly pleased many Turkish citizens. According to Fast FT, "the latest rise in Turkish inflation will seriously test the official aversion to big interest rate rises, with prices up by some 12.98 per cent on the year to November, according to the country’s stats office, up from a gain of 11.9 per cent in the previous month and a 14-year high. Comparisons with last year make for grim reading:"

Goldman Sachs' points to vegetable prices being the major reason for the higher-than expected headline outcome and sees double digit inflation maintained into the final quarter of 2018.

The upside surprise was largely due to vegetable prices which increased by +12.7%mom sa. While we had thought that vegetable prices were going to pose upside risks, the move is far larger than we had thought was plausible, given the recent below average price increases for vegetables.

Going forward, we expect headline inflation to fall as base effects ease. However, the significant surprises to inflation in the last two months raise our end-year 2017 inflation forecast to +12%yoy and the base effects now imply that inflation will remain in double digits into Q4 next year, with inflation going above +11%yoy in 2018Q3. Given the recent TRY weakness, steadily rising inflation expectations and no output gap to exert any disinflationary pressure in our and the TCMB’s views, we think that core inflation is likely to remain close to current levels in the next few months and also remain in double digits till 2018Q4.

The FT highlights the challenge if rampant Turkish inflation is to be brought under control.

The lira is already hovering around record lows on a toxic mix of political tensions and a central bank that is reluctant to jack up rates enough to stop the rot, hampered by the notoriously reluctant President Erdogan.

Therein lies the problem. Turkish Central Bank Governor, Murat Cetinkaya, did point to a likely acceleration in inflation during October and November due to a weaker currency and rising oil prices. However, he expected the inflation rate to begin to moderate from December 2017 onwards. The problem for Cetinkaya, is that markets are demanding significant further tightening in policy to stem the decline in the lira – something which the looming and dictatorial presence of President Recep Erdogan might make problematic. On that note, Fast FT provided some feedback.

Capital Economics writes:  These inflation figures will certainly be alarming for policymakers at the central bank. And while the next MPC meeting on 14th December is likely to be a close call, we think today’s data will be enough to prompt another move to tighten policy. We expect that to come via a 25bp hike in the late liquidity rate – which forms the upper end of the central bank’s interest rate corridor – taking it from 12.25% to 12.50%.

Will that be enough? Tim Ash at BlueBay Asset Management doubts it: Now (there's) no scope for MPC to hide on Dec 14. Surely they have to hike big time.

Finally, here is Goldman's take.

We now think that a rate hike by the TCMB has become the base case, as the pressure on inflation has increased with the currency depreciating more than 15% since September. The TCMB tightened the average cost of funding by 25bp two weeks ago by combining all its funding operations at the upper end of the interest rate corridor – the late liquidity rate at 12.25%. We think that the TCMB will hike the late liquidity rate by 100bp in the next meeting on 14 December, slightly more than markets currently expect. The Bank’s rates policy continues to be driven mostly by concerns about the exchange rate, as it believes that domestic financial conditions are already tightening due to the dissipating impact of the credit guarantee fund. We are sceptical of that assessment, as inflation expectations have been rising significantly, requiring a sharp tightening of rates to re-anchor expectations. We currently forecast a further increase of 100bp in January but think the risk to this remains to the upside.

Turkey’s central bank is about to face its stiffest test.