Could easing be the footsteps of inflation?

While the Central Bank of the Republic of Turkey (CBRT)'s recent interest rate cuts signal a softening of monetary policy, the increase in gross reserves is presented as a 'confidence indicator.' However, market dynamics paint a very different picture.

The Central Bank of the Republic of Turkey (CBRT) is lowering interest rates, reserves are breaking records, but market data says something else...

The Central Bank of the Republic of Turkey (CBRT) reshaped its monetary stance toward "easing" by repeatedly lowering its policy rate in July and September. While these decisions aim to stimulate economic recovery on paper, they have far more complex consequences in real markets. Will this softening signal from the Central Bank lead to growth as expected, or will interest rate cuts be the primary driver of inflation in Turkey? Is the market anticipating sustainable growth or an inflation trap during this period?

Reserve Increase: The Difference Between Appearance and Reality

At first glance, the increase in the Central Bank of the Republic of Turkey (CBRT)'s gross reserves appears to strengthen the monetary authority's hand and is touted as a "confidence indicator." However, the real determinant is the quality of the reserves, rather than their quantity.

Market participants emphasize that this increase is largely due to short-term financial instruments, swap transactions, external borrowing, and forced conversions from export revenues. These resources qualify as "borrowed reserves."

In short, reserves exist, but the truly usable foreign exchange is limited. While the gross reserve record sounds positive, the truly critical indicator is net reserves. The weight of swap reserves, however, poses the risk of these resources rapidly eroding in a crisis.

Therefore, the Central Bank of the Republic of Turkey (CBRT)'s reserve policy will continue to be one of the most critical factors that will test market confidence in the coming period. This situation reflects the impact of financial engineering and temporary foreign exchange inflows rather than the strength of the real economy.

The Effect of Monetary Easing on Inflation

According to classical economic theory, interest rate cuts trigger the following chain:

Interest rates decrease → Liquidity increases → Demand is revived → Production is activated → Inflation increases in a controlled manner.

However, the monetary transmission mechanism works differently in Türkiye:

Interest rates fall → Demand increases → Production capacity is limited → Inflation explodes.

Following interest rate cuts, prices in the marketplace and on supermarket shelves are rising rapidly. This is because Turkey, unable to expand production capacity, is being met with price hikes to meet increased demand. This situation is, in fact, a natural consequence of the demand-pull inflation cycle, the classic monetary transmission mechanism.

Therefore, interest rate cuts trigger "price increases" rather than "investment and production," as in classical theory. In other words, in Turkey, interest rate cuts provide liquidity to the market, but this liquidity becomes fuel for inflation rather than economic growth .

Main differences:

• Import dependency: 80% of industrial inputs are imported, exchange rate volatility is directly reflected in costs.
• Supply constraints: Industrial capacity utilization rate is around 75%; cannot meet additional demand.
• Expectation inflation: The perception that “interest rates are down, a price increase is coming” pushes prices up in advance.
• Currency sensitivity: As the Turkish Lira loses value, import costs increase and the price hike trend accelerates.

According to Central Bank of the Republic of Turkey (CBRT) data, credit growth is accelerating, but the same momentum isn't being observed in industrial production. In other words, liquidity provided to the market is flowing into prices, not production.

Credit Supply and Gold/FX Trend

The expansion of credit in the banking system is one of the unseen drivers of inflation. As interest rates fall, access to credit becomes easier, which boosts disposable income and keeps demand buoyant. However, this "boost" not supported by productive capacity creates inflationary expansion .

Indeed, gold prices also trended upward during this period. As confidence in the Turkish Lira waned, people reflexively turned to gold and foreign currency. This demand not only pushed up exchange rates but also increased import costs, leading to a cascade of price increases.

This surge in gold prices is driving demand for foreign currency not only among individual investors but also among the real sector. While interest rate cuts in developed economies encourage production, in Turkey they are fueling a frenzy of stockpiling and price hikes .

The Central Bank of the Republic of Turkey (CBRT) provides liquidity to the market, but this money is directly reflected in price tags, not production (in the real economy). Consequently, while classical theory predicts "controlled inflation," Turkey is experiencing an "uncontrolled pricing wave."

Year-End Foreign Exchange Demand: A New Wave of Exchange Rate Pressure

As the year draws to a close, exporters and companies with foreign currency debt are increasing their demand for foreign currency to close their balance sheets. During this period, foreign debt payments and balance sheet adjustments naturally put pressure on the exchange rate.

As the Turkish Lira's appeal diminishes with interest rate cuts, investors are choosing to hold foreign currencies. This intensifies exchange rate pressure. The Central Bank of the Republic of Turkey (CBRT)'s swap and currency conversion policies will face their most critical test at this juncture. Exchange rate volatility could peak towards the end of the year.

New Year's Effect: Salary Increases and the Demand Wave

Another factor is the salary increases that will take effect with the start of the new year. These increases will temporarily increase purchasing power in the market. However, since there won't be a corresponding increase in production, this development will fuel demand-pull inflation again. While salary increases will line pockets, the price on shelves could quickly erode this increase.

The result: Seemingly Strong, Deeply Fragile

While monetary easing policies supported by interest rate cuts may appear to stimulate growth in the short term, they carry the risk of damaging price stability in the long run.

While the increase in the Central Bank of the Republic of Turkey (CBRT) reserves may appear to be a sign of strength on the surface, economists consider the underlying resource structure to be fragile. Furthermore, year-end foreign exchange demand, the wave of domestic demand generated by wage increases, and the rise in gold prices could further undermine this position.

Final words: Interest rate cuts in Turkey are increasing prices , not production , as predicted by classical theory. The real economy is responding with price hikes, not production. The solution lies not in financial engineering, but in structural reforms that will increase production capacity.

Dr. Murat ERGÜVEN / Timeturk