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  • Investors appear convinced that inflation is being tamed
  • Central bank has left rates unchanged for four straight months

Turkey’s headline inflation likely saw the sharpest drop in nearly two years in July, a slowdown largely due to base effects that officials may overlook as they focus on more immediate risks to prices.

Annual price growth fell to 62% from 71.6% in June, according to the median forecast of economists canvassed in a Bloomberg survey. Central bankers mainly focus on the month-to-month inflation rate — their preferred metric in shaping monetary policy — which is forecast to accelerate to 3.4%, from 1.6% in June. The data is due to be released at 10 a.m. local time on Monday.

A series of increases in the administered costs of items such as water and electricity will likely underpin price pressures, but on a temporary basis, according to the central bank’s Monetary Policy Committee. Governor Fatih Karahan told Bloomberg in July that while he expects those higher costs to add 1.5 percentage point to monthly inflation, they won’t distort the overall outlook.

“The impact of the energy price changes on inflation expectation will be short-lived,” Goldman Sachs Group Inc. economists led by Kevin Daly said in a report. “Expectations will continue to adjust downward from September onwards reflecting the tightening of income policy and the continued slowdown in domestic demand.”

The central bank most recently forecast annual inflation at 38% at year-end, with Karahan due to present the fresh projections on Aug. 8.

The benchmark interest rate was left at 50% for a fourth consecutive month in July, and domestic demand has finally started to slow. Still, the central bank said demand isn’t easing to the extent that was previously envisaged and price pressures in the services sector remain a risk.

Investors appear convinced that inflation is being tamed and the country is charting a path back to economic normalcy that will supercharge its markets.

Foreign ownership of Turkish stocks and bonds now stands at the highest level in five years, with Amundi SA, Abrdn Plc and Vanguard Asset Services Ltd. among the firms that have been building up positions. More than $30 billion has flowed into the country since May 2023, according to central bank data compiled by Bloomberg, although that includes some funds sent by Turkish banks’ foreign counterparts.

What Bloomberg Economics Says…

“Turkey’s annual inflation is set to tumble by about 10 percentage points in July, chiefly driven by base effects. That would mark the first of two significant moves lower we are expecting, with a similar plunge likely in August. The road beyond the summer will be stickier, though, making a decline to the central bank’s year-end expectation unlikely.”

 Selva Bahar Baziki, economist. Click here to read more.

It remains a challenge to persuade households and businesses of the credibility of the projected inflation path, with their 12-month expectations significantly higher than those reflected in the financial markets. Deputy Governor Cevdet Akcay warned that there would be negative repercussions for unemployment and output if they remained “unresponsive” to restrictive policy.

“To me, the necessary condition to anchor expectations is to establish central bank credibility,” said Selva Demiralp, a former US Federal Reserve economist who now teaches at Istanbul-based Koc University.

“Nobody knows whether the current central bankers will be able to fulfill their promises, or whether they will be sacked abruptly at some point,” Demiralp said. “It is this suspicion that keeps the expectations unanchored based on the experience of the recent past, where five central bank governors were replaced in five years.”

Prior to last year’s national election, President Recep Tayyip Erdogan regularly interfered in monetary policy to push rates down. While new management has been appointed at the central bank and those officials are widely respected by investors, fears remain that history may repeat itself.

Erdogan hasn’t commented on rates since the election, apart from a cryptic message in June when he said inflation would slow further in the final quarter of this year, “with steps” taken on rates.

As price pressures ease and a restrictive monetary policy drags down economic activity, pressure may mount on the central bank to consider cutting rates.

Policymakers have repeatedly spoken out against easing borrowing costs too soon, but Goldman Sachs Group Inc. and JPMorgan Chase & Co. have indicated that a cut could be on the agenda as early as September or October.

“It would be rather inappropriate for the central bank to consider a rate cut, which would cause further deterioration in inflation expectations,” Demiralp said.

Written by:  and  — With assistance from Joel Rinneby @Bloomberg