Impact of supply side shocks on Turkish consumer price inflation in 2007

Data from the first three quarters of last year on national income accounts have shown that the impact of final consumption demand on CPI has been quite limited due to the continued tight monetary measures of the central bank throughout the year. Yet the negative impact of relatively weakened fiscal discipline can not fully account for the current level of the CPI.

As a matter of fact, the dramatic divergence of CPI from the targets stems from external factors such as the prices on energy, commodities and metals. Even worse, it seems that food and energy prices will continue rising due to the effects of global warming. Turkey, which has already been faced with the impacts of global warming, imported about 2 million tons of wheat for the first time recently.

In the figure below, we can see that the role of services (in which price rigidity has been prevalent traditionally) is decreasing whereas the role of energy and unprocessed food is significantly rising.

Two additional observations should be made: First, the central bank should not and cannot respond to or accommodate factors that are out of its monetary reach, such as stagflation, high energy prices and upward adjustments in administrative prices. Second, unlike previous years, it is becoming more apparent that the positive role of a strong Turkish lira in isolating Turkey from external cost push inflationary pressures has been quite limited.

Despite the pressure created by high energy and agricultural prices throughout 2007, the PPI declined to 5.94 percent at the end of the year from 11.6 percent in 2006. As the same pressures will continue in 2008, we do not expect a significant decline on the PPI front. Also, cost side pressures will continue as a major threat to CPI. The overall picture detailed above points to the fact that there is still room for further interest rate cuts.