Is the inflation fore­cast overly op­ti­mistic?

Dünya Executive - - COMMENTARY - Tu­grul BELLI Colum­nist

Things are go­ing well for now, af­ter the Cen­tral Bank’s in­ter­est rate cut, which was well above ex­pec­ta­tions. Turk­ish as­sets con­tinue to be at pre­mium while the TRY is gain­ing value. The TRY has gained more than three per­cent in value in the last two weeks, while 10-year gov­ern­ment bonds have fallen by more than 100 ba­sis points. Of course, the change in the global eco­nomic out­look and the re­turn of the cen­tral banks in all devel­oped coun­tries, es­pe­cially the Fed, have an im­por­tant effect on this pos­i­tive course.

Un­der nor­mal cir­cum­stances, the dis­count could have been more cau­tious. How­ever, as stated in the decision text, “do­mes­tic de­mand developmen­ts and the sup­port of mon­e­tary tight­en­ing for re­duc­ing inflation” seem to have led

to a higher re­duc­tion than expected. As a matter of fact, the third Inflation Re­port of the year, pub­lished a week later, in­di­cated that the main in­di­ca­tors of inflation, sup­ply-based fac­tors and im­port prices pos­i­tively af­fected the inflation out­look. Ac­cord­ing to the re­port, “de­pend­ing on these developmen­ts, cur­rent fore­casts in­di­cate that inflation for the end of the year may be slightly below the fore­casts made in the April Inflation Re­port.” As a re­sult, the Cen­tral Bank reduced the 2019 yearend con­sumer inflation fore­cast to 13.9 per­cent from 14.6 per­cent in the April re­port.

The Cen­tral Bank needs to pay par­tic­u­lar attention to two is­sues in ad­di­tion to many vari­ables when making inflation fore­casts. First, the out­look of the future in­ter­est rate path, in other words, mon­e­tary pol­icy de­ci­sions to be taken by the Cen­tral Bank it­self have an im­pact on future inflation rates. It is clear that the gover­nor, who is in search of a rea­son­able real in­ter­est rate, will con­tinue to cut rates un­der nor­mal con­di­tions and this will cre­ate an ac­cel­er­a­tion in credit vol­ume, which has slowed down con­sid­er­ably re­cently. How­ever, if this ac­cel­er­a­tion is higher than expected, the ex­tent to which credit growth will af­fect the real econ­omy, as well as prices, should be in­te­grated into the model. Frankly, I’m not sure this is the case.

The se­cond point is that when es­ti­mat­ing inflation, the public sec­tor’s deficits that are no longer sustainabl­e and the ad­just­ments in man­aged and guided prod­uct prices, which are the most ef­fec­tive measures to nar­row these deficits in the short term (public hikes in short), need to be pre­dicted in a re­al­is­tic way. In re­cent weeks, there have been a se­ries of hikes. Again, I am not sure that this has been suf­fi­ciently taken into ac­count in the Inflation Re­port. In fact, this is not even in­cluded in the Sources of Fore­cast Up­date ta­ble. It is quite op­ti­mistic that the measures to con­trol the budget deficit, which has wors­ened sig­nif­i­cantly com­pared to the con­di­tions pre­vail­ing in the April Inflation Re­port, will not have an “ad­di­tional” im­pact on inflation in the se­cond half of the year.

As a re­sult, I find the Cen­tral Bank’s 13.9 per­cent year-end CPI fore­cast to be ex­tremely op­ti­mistic, and I be­lieve that ag­gres­sive in­ter­est rate cuts on this fore­cast may be risky.

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