Turkish annual consumer price inflation soared in December to 8.53% from 7% in November, data released by national statistics office TUIK showed on January 3. The figure is well above the official target of 5% for 2017. 

Given the unpromising inflation outlook and Turkey's weak currency, the question is now how the central bank will react when it meets later this month to review its interest rates.

Monthly inflation rose by 1.64% in December versus the 0.93% m/m increase predicted by the market consensus of a Reuters poll. Price surges in food, alcohol and tobacco drove the inflation growth.

The sharp increase in the domestic producer price index seen in the latest data is striking. Producer prices rose by 2.98% m/m in December, bringing the annual PPI inflation to 9.94% from 6.41% in the previous month and signalling that cost pressures are intensifying. At some point, producers feeling the pinch from the weaker currency may have to pass their rising costs on to the consumer. Such a move would impact on consumer spending and hurt consumer confidence, which hit a 14-month low last month.

The central bank has missed its inflation targets for the past six years. By law, when the bank misses its annual inflation target by more than two percentage points, it must write an open letter to the government explaining the reasons for its failure.

Analysts believe that as the lira comes under further pressure the central bank will be left with no other option but to raise interest rates. But the bank may also be pushed by politicians to cut rates to boost economic activity in the run-up to the referendum on the presidential system expected to take place later this year, probably by the summer.

The central bank kept all policy rates unchanged in December, indicating that it was in a wait-and-see mode to gauge the effects of the Federal Reserve’s policies, and other global developments such as oil prices, along with domestic growth dynamics and the effect of the weakening lira on inflation.

“The policy decision - to keep rates unchanged - leaves the lira vulnerable to further depreciation pressures, and increases the chances that the CBRT [central bank] will have to take stronger measures in the future to stabilise the currency, inflation and inflation expectations at some point in the coming months,” analysts at JPMorgan wrote in a research note in December.

JPMorgan assessed that the performance of the lira will be the main determinant of the timing and magnitude of the next CBRT move. “The CBRT will in our view likely remain on hold unless the lira depreciates in a disorderly way.”

Analysts at Capital Economics have pencilled in 150bp of hikes in the overnight lending rate, to 10.00%, by the end of this year.

The market reaction to the December inflation figures was negative. The lira weakened against the US dollar on the disappointing data. It was trading at 3.5788 per dollar as of 10:50 local time, up from the 3.5431 seen before the data release. The main stock market index, the BIST-100, was down 0.28%.

The main culprits behind the higher-than-expected inflation were food, alcohol and tobacco prices, which rose sharply. Food prices rose by 3.29% m/m, adding 0.79 percentage points to the headline inflation rate. The 7.33% m/m increase in alcoholic beverage and tobacco product prices reflected the tax hikes the government introduced in November, adding another 0.37 percentage points to the headline figure. Transport costs rose by 1.97% m/m in the month.

Clothing prices fell by 2.55% m/m, shedding 0.19 percentage points from headline inflation.

The I-index, one of the central bank’s favourite core inflation indicators, increased 0.35% in December versus 0.84% in the previous month. The annual increase in the index eased to 8.47% from 8.64%. The I-index excludes the prices of food, non-alcoholic beverages, alcoholic beverages and tobacco products and gold.

Turkey's CPI Inflation (y/y)
	Weights	Dec-15	May	Jun	Jul	Aug	Sep	Oct	Nov	Dec
Headline	100	8.81	6.58	7.64	8.79	8.05	7.28	7.16	7.00	8.53
Food and non-alcoholic beverages	23.68	10.87	2.47	6.63	9.69	6.19	4.16	5.20	3.55	5.65
Alcoholic beverages and tobacco	4.98	5.68	12.79	12.80	19.36	23.03	22.61	22.61	22.61	31.59
Clothing and footwear	7.43	8.99	7.32	7.31	8.26	7.84	7.03	6.07	4.59	3.98
Housing, utilities	15.93	6.71	6.51	6.68	6.69	6.82	6.64	5.53	5.87	6.42
Furnishings, household equipment	8.02	10.95	9.18	9.75	8.21	8.25	7.13	6.28	5.46	6.24
Health	2.66	7.16	9.58	9.81	10.58	10.60	9.65	9.39	9.16	9.73
Transportation	14.31	6.40	5.72	6.45	6.13	6.74	7.54	8.19	9.57	12.36
Communications	4.42	3.56	2.86	3.07	4.49	3.60	3.12	2.80	3.09	3.18
Recreation and culture	3.81	11.56	8.97	5.97	7.31	5.63	3.97	2.42	4.26	5.93
Education	2.56	6.39	7.56	7.82	7.89	9.18	10.37	9.58	9.50	9.47
Hotels, cafes and restaurants	7.47	13.23	10.59	9.95	9.96	8.63	8.31	8.34	8.50	8.62
Miscellaneous goods and services	4.73	11.00	11.87	11.33	12.68	11.84	10.03	9.34	10.92	11.08
Source: tuik