Target revisions hurt credibility of Turkey's CB

The Governor of Turkish Central Bank Durmus Yilmaz, in a bid to defend the decision, underlined Wednesday setting an inflation target is a social contract and the CBRT tried to remain loyal to it, however structural increases in food and energy prices make the target change inevitable.The CBRT raised its inflation target for 2009 to 7.5 percent from 4 percent late on Tuesday. It also raised its target for 2010 to 6.5 percent and for 2011 to 5.5 percent. The bank said it was doing so because "food and energy prices continue to pose risks to the medium-term inflation outlook and there is no clear evidence that this trend will reverse in the short term". Economists acknowledged the global inflationary risks and it is likely the central banks in Central and Eastern Europe will follow the suit, however it could be considered as a sign that the CBRT had underestimated those risks. "There are widespread price hikes in the economy, necessary or unnecessary, by the agents who set prices. We fear that the central bank lost its credibility and the perception is that the bank is weak in fighting inflation," Fortis Bank chief economist Haluk Burumcekci said.

MISSING TARGETS TWICE

Analysts said the bank, which had already missed its targets for 2006 and 2007 and faced the prospect that it would do so again for a third year, set a looser target for next year to avoid sharp interest rate hikes that would hit economic growth, which began slowing sharply last year due to escalating political tensions and a global credit crunch.Danske Bank said in a research note it is a "huge embarrassment" for the CBRT to miss its inflation target once again, and this has hurt its credibility. "Undoubtedly 'external factors' beyond the CBRT's control, such as food and energy prices, are partly to blame for the rise in inflation, but equally there is no doubt that the CBRT grossly underestimated inflationary pressures in the Turkish economy when it started to cut interest rates last year," Danske Bank Chief Analyst Lars Christensen wrote in a research note late Wednesday.The CBRT's decision to raise the inflation target for the next three years came after the consumer prices inflation rose to double-digit figures for the first time in a year, despite a target of 4 percent.Turkey's inflation rate rose to a 14-month high of 10.7 percent in May from 9.7 percent a month earlier, the government's statistics agency said yesterday. The price of unleaded fuel rose 7 percent from April and food prices jumped 16 percent.PUTTING PRESSURE ON TURKISH ASSETS

The bank's move is likely to make investors even more reluctant to buy longer-term Turkish government bonds and put even more pressure on the bank to keep the lira strong via high carry trade, analysts said.

The lira eased more than 2 percent and benchmark bond yields jumped to their highest since January 2007 after disappointing May inflation and the CBRT's move to raise its inflation targets.

"From a strategy point of view, we see the credibility-denting effect hitting the TRY more than the rate support from the CBRT's call for a continued cautious stance. It will need to remain hawkish against the backdrop of a drop in global risk appetite as well as domestic political uncertainty," said Simon Quijano-Evans, the research director of Unicredit MIB.

The CBRT is expected to continue its rate hikes in its monetary policy meetings in June and July. Turkey's 15.75 percent benchmark interest rate is the highest among major emerging markets