Status: 03.11.2022 1:09 p.m
Turkey’s inflation continues to gallop away and has now hit a record high of 85.5 percent. Experts are convinced: Turkey has not yet reached the peak of inflation.
Inflation in Turkey has peaked: in October, consumer prices were 85.5 percent higher than a year earlier. This is the highest increase in 25 years. In the previous month, inflation was still 83.4 percent. On a monthly basis, consumer prices rose by 3.5 percent in October.
But the end of the inflation flagpole still does not seem to have been reached. This is indicated by the rapid price increases at manufacturer level. Producer prices rose 157.7 percent year-on-year in October. Producer sales prices are an important early indicator of consumer price trends.
Central bank continues to cut interest rates
To make matters worse, the Turkish central bank is sticking to its unorthodox course: Instead of combating the high inflation rates with interest rate hikes, it is further lowering the key interest rate. Just two weeks ago, it announced another reduction in the important interest rate from 12.0 to 10.5 percent.
The Turkish central bank was once again acting at the behest of President Recep Tayyip Erdogan, who, for some unknown reason and contrary to all economic logic, considers interest rate cuts to be a tried and tested remedy for high inflation rates.
Erdogan already in campaign mode?
Tatha Ghose, London-based foreign exchange expert at Commerzbank, is convinced that “there are no real signs of inflation peaking yet,” pointing to wage trends in Turkey. In Turkey, 60 percent of employees work in the low-wage sector, many of them at the minimum wage. This has already been increased twice in the current year: by 50 percent at the beginning of the year and recently by another 30 percent.
“This mechanism will ultimately prolong the upward trend in inflation,” said foreign exchange expert Ghose. “In view of the upcoming elections in June 2023, it can be assumed that Erdogan will offer further drastic wage increases to counteract the consequences of this high inflation rate.”
The wage-price spiral is difficult to stop
In Turkey, the feared wage-price spiral is already in full swing. Economists speak of a wage-price spiral when wages rise in anticipation of persistently high inflation rates. This in turn reinforces the upward trend in consumer prices, which in turn leads to higher wage settlements.
Once started, a wage-price spiral is difficult to stop. The central bank needs to step in and raise interest rates not just a little, but massively. This makes it more lucrative to save instead of spending money. This in turn reduces the demand for goods and services, which pushes down prices. However, drastic interest rate increases would lead to fatal economic collateral damage: A deep recession with enormous economic and social consequences such as company bankruptcies and high unemployment would be inevitable.
How Erdogan damaged the central bank’s reputation
However, despite all the warnings from economists, Turkey is heading towards just such a scenario. Because instead of counteracting the high rates of inflation with moderate interest rate increases at an early stage, the Turkish central bankers have allowed inflation and inflation expectations to continue.
The Turkish central bank now has a massive credibility problem. This is the fault of President Erdogan, who has repeatedly damaged the reputation of this institution by questioning its independence and exerting a strong influence on monetary policy decisions.
Turkish lira at record low
The markets are now convinced that the Turkish central bank is just Erdogan’s puppet. Last but not least, the repeated changes at the head of the central bank at Erdogan’s behest serve as proof. This massive loss of confidence in the international financial markets is also reflected in the exchange rate: the Turkish lira is trading at a record low of $0.0537. Since the beginning of the year alone, it has lost around 30 percent of its value.
The weak lira rate is also contributing to an aggravation of the inflation problem in Turkey: economists speak of imported inflation. Because the weak lira makes it more expensive to import goods or raw materials such as oil from abroad. This in turn drives up consumer prices.
Central bank suddenly self-critical?
In order to strengthen the lira, according to the economic textbook, would the Turkish central bank have to do something again? Exactly: Increase interest rates significantly. But that still doesn’t seem to be an option for the Turkish monetary authorities.
After all, they had to admit last week that the path they have chosen to fight inflation has not been crowned with success: “We cannot consider ourselves very successful,” said central bank governor Sahap Kavcioglu. However, anyone who now thinks that knowledge is the first path to recovery for central bankers is mistaken. Because Kavcioglu added: “God willing, the decisions we have made will lead us to success in a short time.”