With the Turkish lira plunging, it was not exactly a surprise that Turkish inflation data reported today came even hotter than expected, with inflation jumping a surprising 17.9% Y/Y in August, up from 15.9% and above the 17.6% consensus, with monthly inflation rising 2.3%. This was the highest increase in annual inflation going back to 2003.
Core inflation increased from +15.1% Y/Y in July to +17.2%, above the +16.0%expected, and contributed 1.2% to the overall 2.1% rise in the headline figure and more than fully accounted for the surprise in headline inflation compared to forecasts. Following the hike to electricity and natural gas prices, energy inflation contributed another 0.5%. The rest of the increase in headline inflation was due to higher gold and food prices.
As shown in the Goldman chart below, inflation in nonfood goods and energy categories were the main drivers behind the rise in the headline figure.
Looking ahead, Bloomberg economist Ziad Daoud said that Turkey’s year-on-year inflation is likely to jump to 19.1% in August, showing the initial economic impact of the recent meltdown in the lira.
Meanwhile, producer prices soared 32.1%, Turkstat reported on Monday: the PPI's nearly double increase vs CPI confirmed that companies are finding it next to impossible to pass on much of their added costs to end-users just yet, but eventually they will have little choice according to Bloomberg.
According to Bluebay Asset Management strategist Tim Ash the inflation data showed consumer demand collapsing, and it could weaken further if borrowing costs are raised. Still, "if they don’t hike again by something significant, the lira will be left exposed again,” Ash told Bloomberg. “They need to do whatever they need to do short-term to hold the lira, and that means hiking rates."
And while the Turkish lira slumped promptly on the news of the higher than expected inflation, the loss was quickly offset after the Turkey’s central bank stepped in shortly after the inflation data was released, and signaled higher interest rates are imminent: “The monetary stance will be adjusted at the September monetary policy committee meeting in view of the latest developments,” the central bank said in a statement, citing the deterioration in the inflation outlook.
The central bank tipped its hand 10 days before it is scheduled to meet, and in verbal defense of the currency which looked set to resume its slide. As a result, after initially sliding then erasing all losses, the TRY was back to unchanged from its Friday close.
Whether the central bank will actually hike rates - much to the distaste of president Erdogan - remains to be seen. Erdogan has opposed outright tightening, instead placing a premium on economic growth over the lira’s robustness. He’s accused foreign agitators of trying to undermine the Turkish economy by “attacking” the lira, and has said his country can withstand the alleged onslaught.
By signaling a hike, the bank has also created expectations that the increase will be big enough to stem the rise in inflation, according to Piotr Matys, a currency strategist at Rabobank in London. "Such a pledge puts more pressure on the Turkish central bank to deliver a proper rate hike," Matys said. “Essentially, the central bank raised the bar for itself to exceed expectations on Sept. 13.”
The lira has lost more than 40% of its value against the dollar this year even as the central bank raised costs by around 5% points before the latest run on the lira. The bank used fringe tools and an extraordinary lending mechanism to increase the cost of cash it provides to commercial lenders from mid-August to deliver another 150 basis points of tightening.