April expectations in the economy

Last month, when Prime Minister Recep Tayyip Erdoğan said: “April is a very auspicious month” while he was announcing the results of the budget, most people assumed he was referring to the beginning of the process of electing a president during the month. We do not know what April will bring in political terms, but in terms of the economy the month has the potential to be a really auspicious one. But, of course, if this potential to be realized there must not be too much political turbulence.

The most important factor which could make April an auspicious month for the economy is the possibility of it witnessing the beginning of a fall in the rate of inflation. If the expected fall in inflation begins during this month then the Central Bank is expected to consider cutting interest rates from May onwards. The expectation is that a fall in interest rates will boost domestic demand and that the pace of economic growth will accelerate again.

Prospects For Inflation
The reason why there are expectation that April could witness the beginning of a significant decline in inflation is the fact that the rising trend that we saw last year began in the same month. Even if it is was the turbulence on the financial markets in May and June that was the main reason for inflation rising again to double figures last year, the increase began in April, before the turbulence. In fact, one of the factors which fuelled the turbulence on the financial markets was that inflation in April was much higher both than expectations and than the same month the previous year.

As happened this year, inflation began 2006 with a slight rise. But the Central Bank forecast that this rising trend would be temporary and that inflation would begin to fall from April onwards. But this expectation was not realized and, instead of falling, inflation increased significantly in April. The monthly rate of inflation rose from 0.71 percent in April 2005 to 1.34 percent in April 2006. This resulted in the annual rate of inflation increasing from 8.16 percent at the end of March to 8.83 percent at the end of April.

The Central Bank’s Scenario
The Central Bank’s scenario for this year is the same as the one that was not realized last year. According to the forecasts which were published at the end of January in the first Inflation Report of 2007, inflation is expected to remain flat during the first quarter of the year and then decline from April onwards.

Even if the forecasts for year-end inflation are a little high, as far as we can see, the markets agree with this part of the Central Bank’s scenario. Because, if there are no extraordinary developments in the months ahead, the way inflation is moving suggests that is a very high probability of this part of the scenario being realized. Inflation looks as if it will fall from April onwards as a result of the ‘baseline effect’.

When Will There Be A Cut In Interest Rates?
One of the hypotheses on which the Central Bank’s scenario for inflation we have mentioned above is based is that the political interest rates (that is the overnight interest rates the Central Bank applies on the interbank money market) will remain stable until the beginning of the last quarter of 2007 and will then gradually begin to fall. That means that the Central Bank is saying that it will keep interest rates stable until at least October.

But this hypothesis is based on there not being any developments outside the forecast existing economic conditions. If something unforeseen occurs, then of course there will be a change in the Central Bank’s position. At the moment it looks rather as if any developments which cannot currently be foreseen will be positive and the expectation on the markets is that the Central Bank may reduce interest rates earlier, such as from the beginning of May.

The first of the developments which could prompt the Central Bank to cut interest rates ahead of the schedule it has announced would be another fall in the exchange rate. The second would be if market interest rates fell below the overnight rates being applied at the time by the Central Bank. Of course, these developments would not single-handedly prompt the Central Bank to cut interest rates ahead of schedule. But if they were also supported by a number of other developments, then there is certainly the possibility of them producing such a result.

The Presidential Election
We believe that the most important of the developments which we have mentioned will occur during the presidential elections. Indeed, at the moment, the cautious attitude that some have adopted towards the domestic economy is as much based on the possibility of political tensions during the elections process as on the high interest rates. This is the reason consumers are postponing large-scale consumption decisions and investors investment decisions. We believe that the Central Bank’s cautious attitude towards its interest rate policies is based more on concerns about the uncertainty surrounding the presidential rather than the general elections.

If the presidential elections pass off without the tensions which many fear and the month of April is, as Prime Minister Erdoğan has predicted, a truly auspicious month, then this excessively cautious mood in the economy will disappear. The Central Bank will no longer need to keep interest rates at such a high level. If inflation begins to fall as expected in April, a decision may be taken at the meeting to the Monetary Policy Committee on 14 May to cut interest rates.

Unemployment Is Falling
The labor force data for November, which were released last month by the Turkish Statistical Institute (TÜİK), are calculated on the results of surveys conducted in October, November and December and thus also serve as data for the fourth quarter of the year. The quarterly statistics for unemployment show that there was a significant fall in unemployment during 2006.

The unemployment rate in the last quarter of 2006 was 9.6 percent. This represents a one percentage point fall compared with the same period in 2005.
The unemployment rates for the second and third quarter of 2006 declined when compared with the same periods the previous year. This indicates that the unemployment rate for the whole of 2006, which will be announced on 6 March, will be below that of 2005. It looks as though the unemployment rate, which rose to double figures in 2002 and was 10.3 percent in 2005, will have fallen to single figures in 2006.

It is not only the rate but also the total number of the unemployed that has fallen. In the last quarter of 2006 the number of unemployed fell by 196,000. In the second quarter of 2006 the decline was 79,000 and in the third quarter it was 38,000.

The fall in the rate of unemployment is a result of five years of rapid economic growth. In order for the decline in unemployment to continue then rapid economic growth must also be sustained.