Turkey’s official inflation rate was on September 3 announced as unchanged between July and August, at 11.8% y/y, while the day also saw the Turkish lira (TRY) drop to a new record low of 7.4535 versus the dollar.

Analysts pointed out it was the trajectory of the lira rather than that of inflation that was likely to determine the next moves of the Turkish central bank—widely seen as hamstrung by Turkish President Recep Tayyip Erdogan, who has his face set against orthodox monetary policy that would suggest rate hikes are in order, and thus limited to tightening monetary policy with backdoor and fringe moves.

“If the lira’s recent stability proves short-lived—as we think likely—a further tightening of monetary conditions via the interest rate ‘corridor’ lies in store,” wrote Capital Economics economist Jason Tuvey in a note to investors sent out before the day sent the lira to its fresh all-time low.

Renewed downward pressure on the lira—down around 8% against the dollar since late July and 20% in the year to date—would prompt the central bank to shift liquidity provision to its late liquidity window, which forms the top end of the rate corridor with an interest rate of 11.25%, said Tuvey. The national lender’s weighted average cost of funding currently stands at 10.16% compared to its key rate, the one-week repo rate, which stands at 8.25%. “Political pressure means that hikes to policy interest rates are likely to be a last resort,” Tuvey added.

Close eye

Investors have this week kept a close eye on whether the central bank has reached an end to its backdoor tightening steps. As a result of those steps, the weighted average cost of funding has risen gradually over the past several weeks from 7.34% to 10.16%. There was no change in the rate on September 2, after the rate on traditional repo auctions declined towards 10% over previous days. That led analysts to question whether the tightening moves were over.

Looking at the central bank’s dilemma, Ziad Daoud, an analyst at Bloomberg Economics, said: “Currency depreciation remains a lingering threat and could keep Turkey’s price growth in double digits throughout the year. The lira’s weakening so far this year poses upward risks to the central bank’s inflation outlook.”

Sebastien Barbe, the Paris-based head of emerging-market research and strategy at Credit Agricole, said: “In order to hike the one-week repo rate, it [the central bank] will have to overcome Erdogan’s reluctance to let this happen. This could occur when the depreciation pressure on the lira intensifies further, possibly in the course of the fourth quarter.”

Touch weaker

The headline annual inflation outturn was just a touch weaker than consensus forecasts.

The breakdown of the data showed that alcohol and tobacco inflation dropped sharply, from 21.8% y/y in July to 2.4% y/y last month, as the effects of sharp tax hikes last year fell out of the annual price comparison, Capital said, adding: “This shaved 1.0%-pt off the headline rate. Meanwhile, education inflation fell close to a five-year low of 8.5% y/y. Clothing, as well as housing and utilities, inflation also eased.”

Transport inflation leapt to a seven-month high of 12.7% y/y as the fall in the lira and higher global oil prices raised local fuel prices. Food inflation climbe to 13.5% y/y and there were also increases in furnishings and hotels and restaurants inflation. Core inflation climbed to a one-year high of 11.0% y/y.

“The central bank (CBRT) has raised concerns in its recent communications about the inflation outlook and the CBRT’s forecast that the headline rate will fall back to 8.9% y/y by the end of this year is overly optimistic,” added Tuvey. “We think that inflation will hover around its current rate over the next 6-9 months. And while the recent tightening of monetary conditions appears to have steadied the lira, the currency remains vulnerable to a fresh sell-off—particularly if tensions with the EU [over matters including east Mediterranean gas exploration in disputed waters] ratchet up.”

Month-on-month, consumer prices rose 0.86% in August, according to the official data released by the Turkish Statistical Institute (TUIK), compared to a Reuters poll forecast of 1%. The producer price index rose 2.35% m/m in August for an annual rise of 11.53%, the data also showed.

Annual inflation last touched the central bank's 5% target in 2011.