Turkey Inflation to Hit a Bump as Central Bank Tees Up Rate Cuts

(Bloomberg) -- A slowdown in Turkish inflation probably took a pause as the government rebuilds its coffers with higher taxes while the central bank loosens monetary policy.

The setback may prove to be little more than a blip, driven mainly by electricity price increases and the phasing out of a tax cut on automobiles. Data on Monday will show inflation accelerated for the first time in four months, climbing to an annual 16.9% in July from 15.7% in June, according to the median of 20 forecasts in a Bloomberg survey.

Monthly “inflation is negative, excluding the one-time price hikes,” said Okan Ertem, senior economist at Turk Ekonomi Bankasi who had the most accurate forecast of June prices. “This trend will go on as long as currency stabilization and slow economic activity continue.”

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The central bank is waiting for the downswing to resume as it cuts interest rates for the first time in three years under new Governor Murat Uysal. Policy makers expect the disinflationary momentum to strengthen again in the coming months thanks to base effects, with the latest projections showing price growth will slow more than previously forecast and end the year at 13.9%.

Despite the deceleration, and President Recep Tayyip Erdogan's calls for steeper rate cuts, Uysal has vowed to preserve “a reasonable rate of real return” for investors. At his first meeting in charge of the central bank, the Monetary Policy Committee slashed the benchmark borrowing rate by 425 basis points, the most in at least 17 years, to 19.75%.

At just over 400 basis points, Turkey's real rate is now around 70 basis points above the average for major emerging markets. If inflation goes up in line with forecasts in July, the interest rate adjusted for inflation would be lower by about 100 basis points.

With the economy reeling from a currency crisis last summer, Treasury and Finance Minister Berat Albayrak rolled out significant tax breaks at the end of October to support waning domestic demand in automotive sector.

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• A special tax applied to cars with engine sizes that account for nearly 60% of the market was reduced by 15 percentage points and the valued-added tax on commercial vehicles was slashed to 1% from 18%. The incentives expired in June
• The government also raised electricity prices by 15% from July 1. The increase may add 0.44 percentage points to consumer prices, according to Oyak Securities
• A slowdown in the cost of food and clothing is offsetting the effect of the tax waivers running out and other price pressures; retail food prices dropped a monthly 0.36% in Istanbul in July

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“We expect inflation to decline in August once again and fall significantly in September/October, reaching single digits temporarily on the back of strong base effects, before rising once again,” Goldman Sachs Group Inc. including Kevin Daly said in a report.

--With assistance from Harumi Ichikura and Constantine Courcoulas.

To contact the reporter on this story: Cagan Koc in Istanbul at ckoc2@bloomberg.net

To contact the editors responsible for this story: Onur Ant at oant@bloomberg.net, Paul Abelsky, Constantine Courcoulas

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