Photo: Reuters/Murad Sezer

The deterioration in Turkey’s inflation dynamic seems to be secular, not dynamic, write Citibank analysts. They add that markets may be too optimistic about the ability of the central bank to ease the rate of inflation and thus about the bond market:

While the exchange rate is one of the most important variables affecting inflation, one also needs to take cyclical factors into consideration. With this backdrop in mind, we consider two models. In the first one, inflation forecast errors are expressed as a function of USDTRY forecast errors, oil price surprises as well as deviation of food and tobacco prices from their respective historical averages. In the second model, we also include a variable to capture other cyclical factors at the time of the survey.

Our empirical findings suggest that forecasters’ optimism regarding the performance of the lira is the key driver of the under-prediction of inflation

It is interesting to note that food and tobacco prices don’t play a significant role in explaining the bias toward under-prediction of inflation when we consider the full sample. Concerning this year, while the exchange rate (0.96pp) continues to be the key driver, food (0.57pp) and tobacco (0.50pp) prices also play an important role in explaining the average forecast error (2.7pp) during the January-July period.

All in all, the empirical findings reinforce our previous analyses calling for a more cautious assessment of the inflation outlook

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