Economy in Turkey: New Era in Interest Rate and Wage Policy

June Inflation Data and Initial Implications: The inflation data for June has been released, showing a monthly CPI increase of 1.4%, slightly below market expectations. In May, monthly inflation had also risen by 1.5%, which helped bring the annual inflation rate down to 35%. This created a gap of 11 percentage points between consumer inflation and the central bank’s policy rate.

Meanwhile, global risk perceptions, which had spiked during the Israel–Iran conflict, have significantly subsided, making way for a “bull market” sentiment in international financial markets. These developments now provide the Central Bank with the space to begin its anticipated interest rate cuts this month.

Pace and Scale of Interest Rate Cuts

Following this widely expected move, the critical question now becomes how fast and how deep the rate cuts will be. Unfortunately, given the dynamics of expectations, pricing behavior, risk factors, and structural constraints, the rate-cutting cycle is unlikely to bring the kind of relief the real sector and households might hope for. The projection is that the Central Bank will initiate a rate cut of around three percentage points in July, while maintaining a relatively high real interest rate margin and tight financial conditions in the subsequent period.

Inflation Target Remains Distant

Even though annual inflation has eased to 35%, this is still far above the Central Bank’s year-end target of 24%. Additionally, with the long-term inflation target officially held at 5%, the need for a sustained high real interest rate margin remains evident in the absence of any unexpected structural improvements.

Stubbornness in Inflation Expectations

While some sectoral inflation expectations have improved, the overall expectation channel is still far from supporting a disinflationary trend. Market participants currently forecast year-end inflation around 30%, which may decline slightly to align with the Central Bank’s upper target band of 29% in the next survey. However, among businesses and households, the improvement in expectations will likely take much longer. One-year-ahead inflation expectations stand at 40% for the real sector and 53% for households—far above the actual inflation readings for May and June. This highlights the fragility of the expectations framework.

Structural Rigidity in Service Inflation

Despite headline inflation surprising on the downside, service-sector inflation remains persistently high. In June, service inflation rose by 2.7% on a monthly basis—twice the pace of the overall CPI. Price increases accelerated in restaurants, transportation, and accommodation services, driven by the tourism season. However, the main structural pressure stems from rent-related housing costs, which increased by 4% in June alone. This stickiness in service inflation limits the room for maneuver in monetary policy.

Producer Inflation on the Rise

While consumer inflation is decelerating, producer prices are showing an upward trend. In June, the Producer Price Index (PPI) rose by 2.46% compared to the previous month, with a cumulative increase of 15.7% since the beginning of the year. This acceleration is fueled by global trade tensions, supply chain disruptions, rising financing costs, and increased labor input expenses. Although weak domestic demand has thus far limited the pass-through of producer prices to consumer prices, this pressure is likely to feed into CPI over time.

Persistently High Risk Premium

Turkey’s risk indicators remain significantly above historical averages and those of peer countries. Factors such as high CDS premiums, inadequate foreign exchange reserves, limited portfolio inflows, and the elevated share of foreign currency deposits all reinforce the Central Bank’s need to maintain positive real interest rates. Therefore, even as the policy rate is lowered, the real interest margin must be preserved, and financial conditions must remain tight.

Wage Policy Remains Restrictive

A key pillar of the current economic strategy involves controlling domestic demand and inflation through wage restraint via regulated and administered pricing. Following the 2023 elections, limited increases were granted to the minimum wage, public sector salaries, and pensions, illustrating this approach. With relatively moderate monthly inflation readings in May and June, CPI rose 16.7% in the first half of the year. Any upcoming wage and salary adjustments based on this increase are unlikely to meaningfully improve household purchasing power.

No Significant Relief in Sight for Next Year

Although interest rates are expected to decline in the second half of the year, cautious monetary policy and tight macro-financial conditions will keep credit access limited and borrowing costs high. Another consequence of the interest rate policy is a strong real exchange rate, which will continue to weigh on exporters. On the consumer side, restrictive wage policy and limited credit access point to a continued erosion in overall welfare.

Conclusion

While the Central Bank may begin easing interest rates, there can be no lasting relief for either the real sector or households until a decisive victory is achieved in the fight against inflation.

(Edited and translated from article on ekonomim.com by Dr. Burcu AYDIN)