How is Turkey chasing the inflation specter?

While the European Union is struggling with low inflation, it is far too high in Turkey. However, as long as the central bank is not given a free hand, the lira will continue to slide.

Dutch inflation has risen sharply. The average price increase of a basket of consumer products that the Central Bureau of Statistics (CBS) keeps track of was 2,6% in February. However, that increase is child's play with what is now happening in Turkey, where inflation has been above 20% for some time. Will Turkey succeed in controlling inflation in 2019, and what does that mean for the Turkish lira?

Takes too long
Keeping inflation in check is the most important task of the central bank for many countries. In Europe, the European Central Bank has already cut its key interest rate to 2016% in 0, hoping to fuel inflation. If inflation is too high, you expect a central bank to raise interest rates.

However, the Turkish Central Bank has waited a long time for that. Under pressure from President Recep Tayyip ErdoÄŸan, who feared high interest rates would curb economic growth, the key rate has hovered around 2015% to 7% from mid-8. That was much lower than inflation.

Interest of 24%
However, the bank raised interest rates in 2018 to as much as 24% within a few months. The main reason for this was the free fall of the Turkish lira. Between January 2018 and mid-August, the currency fell by more than 40% against the euro. The lira has been under pressure for some time, mainly due to high inflation and the dwindling supply of foreign currencies.

This decline then accelerated when the United States threatened trade measures amid a conflict over the release of American pastor Andrew Brunson. Brunson has since been released and the lira has recovered somewhat; although inflation remains astonishingly high.

Free hand
A bright spot is that inflation in February was just below 20%: 19,7%, the lowest level in six months. This improvement is mainly due to government measures; the supermarkets that increased their prices, for example, could count on a fine. While these artificial measures may provide some relief in the short term, in the long run it could slow growth and damage the economy.

The outlook improves when the Turkish bank is given a free hand. The chances of that happening are slim and a new fall in the lira cannot be ruled out for the time being. Which is actually good news for those who are considering going on holiday in Turkey later this year or in 2020.

Joost Derks

Joost Derks is a currency specialist at iBanFirst. He has over twenty years of experience in the currency world. This column reflects his personal opinion and is not intended as professional (investment) advice.

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