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Inflation in January accelerated above expectations due to a surge in food prices. We anticipate that inflation will end the year well above the central bank target of 5.3%.
January inflation accelerates above expectations. Headline CPI came out at 7.3% yoy in January from the 2012 year-end reading of 6.2% yoy. Although the expectation was for an acceleration in prices (Bloomberg consensus: 6.8% yoy) due to the impact of a tobacco tax increase that came into effect at the start of the year, the outturn still significantly exceeded this.
Inflation breakdown indicates that food prices are the main contributor to the rise. The tobacco tax increase added 0.8% to inflation, in line with the CBRT estimate. The remainder of the rise in inflation can be attributed to food prices, which rose 6.9% yoy from just 3.9% yoy in December 2012. Given the significant food price weighting in the CPI basket of 24%, this contributed significantly to the acceleration in prices.
We expect inflation to end the year well above the CBRT estimate of 5.3%. In the Q1 inflation report released last week, the CBRT indicated that it expects inflation to resume its downward trend towards the 5.3% year-end projection, following an initial rise in January. The Central Bank said it expects the favourable impact of unprocessed food prices on headline inflation to fade gradually. According to the CBRT, unprocessed food price inflation in Turkey is three to four times more volatile than in other countries. Therefore we think that the favourable impact observed in 2012 from this component will likely reverse in 2013, which should contribute to a substantial rise in inflation. Although CPI rose significantly in January, we note that unprocessed food price inflation was once again a negative contribution. Once this component begins to pick up, it will likely feed through to a sharp rise in inflation, which makes inflation linked bonds attractive in our opinion.
Monetary policy is currently focussed on private sector credit growth and capital inflows. Recent comments from the Central Bank suggest that it is currently more concerned with the recent surge in private sector credit growth and capital inflows. The CBRT reacted to this at the last MPC meeting by shifting the interest rate corridor down by 25bp to cool capital inflows and lira appreciation, while hiking reserve requirements for TRY and FX deposits to contain consumer credit expansion.
We anticipate further macro prudential tinkering. We expect private sector credit growth to exceed the 15% yoy estimate of the CBRT, as local banks reduce some of their exposure to government bonds and increase lending to the real economy. As a result, we expect further reserve requirement ratio hikes at upcoming MPC meetings to slow down credit growth, in an attempt to prevent the CAD from widening once again.
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