Cautious Mood Ahead of CBRT Rate Decision: Fiscal Risks Threaten Inflation Goals

Summary:

On the eve of the Central Bank of Turkey’s (CBRT) policy meeting, analysts and institutions are warning that Turkey’s inflation outlook remains fragile despite recent declines. Expectations for a 100–150 basis point rate cut clash with calls for caution from economists who stress that fiscal expansion and political uncertainty continue to undermine disinflation efforts. The Economic Policy Research Foundation of Turkey (TEPAV) has warned that without structural and judicial reforms, sustainable price stability will remain out of reach.

Markets Brace for a Critical Policy Moment

The final two days of the week bring two events that could shape Turkey’s short-term outlook: the CHP congress case and the CBRT’s rate decision. Following disappointing August–September inflation data, investors are divided on whether the central bank will prioritize credibility or growth.

While Treasury and Finance Minister Mehmet Şimşek has acknowledged that inflation will remain above 30% through end-2025, the government’s official target of 16% for 2026 looks increasingly unrealistic. Market expectations currently point to a cut of 100–150 basis points — a move that analysts say could weaken the lira’s appeal and limit the carry trade inflows that underpin recent stability.

Reserves Under Pressure as FX Sales Continue

In the past six weeks, the CBRT has reportedly sold nearly $18 billion from its reserves to meet domestic FX demand. Additionally, the decline in gold prices last week likely caused a further $7 billion reduction in gross reserves.
While these numbers do not yet suggest an immediate loss of control over the lira, they indicate that the positive market sentiment may be starting to fade.

TEPAV Warns: “Do Not Cut Rates”

A new policy note from TEPAV’s Macroeconomic Working Group cautions that financial stability risks are rising and urges the CBRT to avoid premature rate cuts. Although inflation has declined since May 2024, TEPAV highlights the growing difficulty of sustaining this progress amid policy gaps and increasing political uncertainty.

The report outlines a roadmap for a credible anti-inflation strategy:

• Reduce domestic uncertainty by restoring rule of law and judicial independence.

• Design a new, inclusive development strategy capable of inspiring public confidence.

• Align fiscal policy with monetary tightening through comprehensive tax reform, spending discipline, and stronger oversight of off-budget guarantees.

• Ensure administered prices support disinflation instead of working against it.

• Protect the independence of economic institutions such as the CBRT, TÜİK, and BDDK.

Inflation Driven by Fiscal Expansion

A separate TEPAV study by Program Director Prof. Dr. Hakkı Hakan Yılmaz underscores that Turkey’s inflation is increasingly driven by fiscal policy rather than monetary dynamics.
According to Yılmaz, rising government spending and indirect taxes have intensified inflationary pressure — and this effect will become even clearer in 2026.

Excluding earthquake-related spending, public expenditures rose by 41.8% year-on-year, while tax revenues jumped 46.8%. If this trend continues, expenditures could exceed the GDP deflator by 4–7 points, and taxes by as much as 12 points.

Yılmaz concludes that the official 2026 inflation target of 16% is unattainable. Even under conservative assumptions, the gap between inflation and fiscal performance could reach 7–11 percentage points.

“Loose Fiscal Policy Is Undermining the Inflation Fight”

Yılmaz argues that without a disciplined fiscal framework, inflation expectations cannot be anchored:

“If fiscal consolidation had been implemented decisively, inflation this year could have been 5–6 points lower.”

Short-term tax hikes may offer temporary revenue relief, but without improving the quality of public spending and restoring fiscal discipline, the 2026 target will remain out of reach.