2.1 Price Stability and Monetary Policy

2.1.1 Overview

Economic activity remained robust in the first quarter of 2024 on the back of wage adjustments and brought-forward demand, while the effects of monetary tightening on economic activity were particularly pronounced in the second and third quarters. Household demand was strong in the last quarter of the year due to campaigns and upcoming wage revisions. Against this backdrop, the contribution of domestic demand and net exports to growth remained balanced throughout 2024, pointing to a healthier growth outlook. Consistent with this rebalancing, economic activity slowed on an annual basis in 2024, with a growth rate of 3.2%. On the production side, the services sector was the main driver of growth during the year, while the construction sector also made an upward contribution to growth.

In 2024, exports rose year-on-year, while imports declined. The 12-month cumulative current account deficit narrowed sharply to USD 10 billion in 2024 amid the decline in the foreign trade deficit and the robust services balance. This trend in the services balance had a favorable impact on the current account balance, while improvements in the gold balance, the energy balance, and the core foreign trade balance supported the fall in the current account deficit.

Key labor market indicators pointed to a strong labor market in 2024. Total employment increased by 984 thousand people year-on-year, while the unemployment rate fell by 0.7 percentage points to 8.7%.

The disinflation process started in June and remained on track in the second half of the year, with annual inflation standing at 44.4% at end-2024. Domestic demand conditions, which tended to weaken throughout the year due to monetary tightening, reached levels supportive of disinflation in the second half of the year. Credit utilization posted increases in the first half of the year but remained moderate in the remainder of the year owing to the macroprudential measures. Depreciation of the Turkish lira being more limited compared to last year alleviated inflationary pressures through this channel. Wage-driven effects were more noticeable in the first half of the year and less so in the second half. Following a modest increase in the first quarter, commodity prices decreased for the rest of the year, led by the energy group. Inflation expectations hovered above inflation forecasts yet declined throughout the year. In 2024, annual producer inflation remained below consumer inflation at 28.5%. At end-2024, annual inflation in core B and C indicators fell by 24.1 and 25.3 percentage points year-on-year to 43.9% and 45.3%, respectively.

The monetary policy stance is determined to ensure that inflation remains aligned with the targeted path and the disinflation process moves forward. The CBRT raised the policy rate to 50% in March 2024 as part of the strong monetary tightening process that began in June 2023 to establish disinflation as soon as possible, anchor inflation expectations, and contain the deterioration in pricing behavior. In March, the CBRT also adjusted the operational framework and decided to set the overnight borrowing and lending rates 300 basis points below and above the one-week repo auction rate, respectively. In the April-November period, the CBRT kept the policy rate unchanged at 50%, remaining highly attentive to the upside risks to inflation. In December, the CBRT concluded that leading indicators pointed to a decline in the underlying trend of inflation and that domestic demand, standing at disinflationary levels, further slowed. The CBRT thus reduced the policy rate from 50% to 47.5% in December and decided to set the overnight borrowing and lending rates 150 basis points below and above the one-week repo auction rate, respectively. The CBRT continued to implement macroprudential policies in 2024 to enhance the effectiveness of monetary transmission against the divergence in expectations of economic units and possible volatility. Accordingly, regulations regarding deposits, loans, and liquidity management were introduced.

2.1.2 Developments in 2024

Monetary Policy Developments

The CBRT raised the policy rate from 42.5% in December 2023 to 45% in January 2024, with an increase of 250 basis points, assessing that the monetary tightness required to establish disinflation was achieved. However, taking into account the lagged effects of monetary tightening, the CBRT indicated that this level would be maintained as long as needed. The Bank emphasized that the current level of the policy rate would be maintained until there was a significant decline in the underlying trend of monthly inflation and inflation expectations converged to the projected forecast range. In February, the CBRT kept the policy rate unchanged at 45%. On the other hand, recent indicators suggested that the resilient course of domestic demand continued to strengthen relative to the last quarter of 2023, due in part to the changes in the calculation methodology. In February, the underlying trend of monthly inflation also turned out higher than projections, led by services inflation. Medium-term inflation expectations continued to decline, while year-end inflation expectations for 2024 and 2025 rose. Accordingly, in response to the deterioration in the inflation outlook, the CBRT raised the policy rate to 50% in March (Chart 2.1.2.1). Additionally, the CBRT made a technical adjustment and set the overnight borrowing and lending rates 300 basis points below and above the one-week repo auction rate, respectively.

The steps taken in March resulted in a significant tightening in financial conditions. Stating that the effects of the monetary tightening on loans and domestic demand were closely monitored, the CBRT kept the policy rate unchanged in April, taking into account the lagged effects of the tightening. The Bank underscored that it remained highly attentive to upside risks to inflation, maintaining its forward guidance that the monetary policy stance would be tightened in case of a significant and persistent deterioration in inflation. The decline in the underlying trend of monthly inflation in April registered a temporary pause in May. Subsequently, a stronger-than-expected decline in June was replaced by a limited and temporary increase in July. Recent indicators confirmed that domestic demand had decelerated, albeit still at inflationary levels. Accordingly, the CBRT kept the policy rate unchanged in the May-July period, taking into account the lagged effects of monetary tightening. Meanwhile, the CBRT reiterated its communication that it remained highly attentive to upside risks to inflation. The Bank maintained its forward guidance that the tight monetary policy stance would be maintained until there was a significant and sustained decline in the underlying trend of monthly inflation and inflation expectations converged to the projected forecast range and that the monetary policy stance would be tightened in case of a significant and persistent deterioration in inflation.

Indicators for the third quarter of 2024 indicated that domestic demand further slowed, with a diminishing inflationary impact. The underlying trend of inflation remained broadly unchanged in August, rose slightly in September, and then decelerated in October. Accordingly, the CBRT kept the policy rate unchanged at 50% in the August-October period. The CBRT maintained that the alignment of inflation expectations and pricing behavior with projections remained a risk factor for the disinflation process. At the October meeting, the CBRT stated that uncertainties regarding the pace of improvement in inflation had increased in light of incoming data. The Bank highlighted that the tight monetary policy stance would be maintained until there was a significant and sustained decline in the underlying trend of monthly inflation and inflation expectations converged to the projected forecast range. The CBRT also stated that monetary policy tools would be used effectively in case of a significant and persistent deterioration in inflation.

In November, the CBRT reiterated that it was highly attentive to upside risks to inflation, keeping the policy rate unchanged at 50%. In December, the CBRT reduced the policy rate by 250 basis points to 47.5%. Besides, the Bank adjusted the operational framework by setting the overnight borrowing and lending rates 150 basis points below and above the one-week repo auction rate, respectively. The CBRT emphasized that the decisiveness regarding the tight monetary stance brought down the underlying trend of monthly inflation and strengthened the disinflation process through moderation in domestic demand, real appreciation of the Turkish lira, and improvement in inflation expectations, adding that increased coordination of fiscal policy would also contribute significantly to this process.

In 2024, the CBRT kept adopting quantitative tightening decisions to eliminate excess Turkish lira liquidity in an effort to support monetary tightening. While affecting the policy rate - the main policy instrument - monetary and financial conditions, and expectations, these decisions also stabilized excess Turkish lira liquidity and contributed to enhancing the effectiveness of monetary policy. Moreover, the transmission mechanism was strengthened, and the funding composition of the banking system was improved through regulations to increase the share of Turkish lira deposits, accompanied by monetary tightening. As part of the simplification in the macroprudential framework to enhance the functionality of the market mechanism, the CBRT abolished the securities maintenance regulation with the amendment issued in May and terminated the additional reserve requirement practice based on the leverage ratio with the regulation introduced in June.

In 2024, the CBRT took further steps to reinforce the monetary transmission mechanism. Accordingly, in line with the CBRT’s objective of gradually phasing out FX-protected deposit accounts (KKM accounts) by switching to Turkish lira, the CBRT included legal person KKM accounts in the calculation of the total target for KKM accounts’ transition to Turkish lira and renewals. Additionally, the remuneration of reserve requirements maintained for KKM accounts has been terminated for new KKM accounts or for those to be renewed. In the “Monetary Policy for 2025” document, the CBRT states that as the disinflation process becomes more evident, the demand for Turkish lira assets will continue, and in view of the rise in the ratio of Turkish lira deposits and the fall in KKM accounts, the CBRT will continue to simplify the macroprudential framework and terminate the KKM scheme in 2025.

At the beginning of 2024, the funding need of the banking system (FNS) pointed to a liquidity shortage of TRY 1,012 billion, whereas the excess liquidity, which became permanent since September 2024, stood at TRY 302 billion on December 31, 2024 (Chart 2.1.2.2). This excess liquidity was sterilized through net open market operations (OMO) of TRY 250 billion, and sell-side Turkish lira currency/gold swap auctions (reverse swap) of TRY 52 billion. In 2024, the TRY 1,329 billion decline in the FNS was primarily driven by the improvement in the CBRT’s net FX position. Reserve requirement regulations, the change in the volume of banknotes in circulation, and the change in the amount of net domestic borrowing of the Ministry of Treasury and Finance of the Republic of Türkiye (the Treasury) were the factors that increased the funding need of the system.

To contribute to banks’ Turkish lira and FX liquidity management, the CBRT continued to conduct buy-side swap auctions via the traditional method in the first half of 2024. On the other hand, during the process of gradually reducing the CBRT’s swap transaction amount as stated in the Monetary Policy for 2024, the CBRT’s outstanding swap balance was reduced to zero as of July 31. Upon the accumulation of excess liquidity in the system, the CBRT started to conduct sell-side currency swap auctions in August, and sell-side gold swap auctions in October, with a view to diversifying the sterilization toolset.

In 2024, the diversified liquidity toolset helped to support the effectiveness of sterilization operations. In the first half of the year, the excess liquidity was sterilized through Turkish lira deposit buying auctions and quotation at the Borsa Istanbul (BIST) Repo/Reverse Repo Market, the BIST Committed Transactions Market (CTM), and the CBRT’s Interbank Money Market (IMM). In the second half of the year, the diversified set of tools was gradually put into use, and the CBRT started to conduct Turkish lira deposit buying auctions at different maturities on the same day. Moreover, the excess liquidity was sterilized through sell-side Turkish lira currency/gold swap auctions and quotation at the Takasbank Money Market (TMM). As a result of the sterilization operations through various channels, short-term interest rates in the money markets became more aligned with the CBRT’s policy rate, and interest rate volatility decreased significantly (Chart 2.1.2.1).

Inflation Developments

Annual consumer inflation rose in the first quarter of 2024. This was due to wage revisions and the backward-indexation behavior in items with a high time-dependent pricing tendency, as well as cost-side effects. In May, annual consumer inflation peaked due to the expiry of the free use of the 25 cubic meters of natural gas for households as well as the low base effect caused by the free use of natural gas in the same period of the previous year. As of June, the disinflation process began, and in the third quarter, energy prices and the lump sum tax revisions as well as price developments in administered items had a notable impact on consumer inflation. In the fourth quarter of the year, annual consumer inflation remained on a downtrend; however, unprocessed food prices continued to be a factor limiting a more favorable course in headline inflation due to temporary supply conditions. In December, the slowdown in monthly consumer inflation became more evident, and with the improvement in the underlying inflation, annual consumer inflation ended the year at 44.4%, close to the mid-point of the 2024 IR-IV forecast (Chart 2.1.2.3). At the end of 2024, annual inflation in core inflation indicators B and C indices stood at 43.9% and 45.3%, respectively, indicating a year-on-year decrease of 24.1 and 25.3 percentage points, respectively.

In 2024, backward-indexation behavior had a substantial effect on the course of consumer inflation. The backward-indexation behavior led to the maintenance of inertia in services inflation, especially notable in the rent subgroup. Wage-driven pressures were evident in the first half of the year but were weaker in the second half. Domestic demand conditions, which weakened throughout the year, reached levels supportive of disinflation in the second half of the year. The more limited depreciation of the Turkish lira compared to previous years, eased the inflationary pressures through this channel. After rising until April, commodity prices were on a downward trend for the rest of the year, led by the energy group. Inflation expectations decreased throughout the year, yet they remained above the Inflation Report’s forecasts (Chart 2.1.2.4). In the first months of the year, annual producer inflation increased, and in the second half of the year, producer price pressures weakened on the back of favorable global cost conditions, stable exchange rates, and a mild course of real unit labor costs. Thus, the annual increase in producer prices remained below the consumer inflation at 28.5% in 2024.

Across subgroups, food and core goods groups were the main contributors to the fall in annual inflation, followed by services. In 2024, the contribution of energy group was inflationary. In April, annual inflation in the food and non-alcoholic beverages group fell below the headline inflation for the first time in three years, ending the year close to consumer prices. Across subgroups, the main driver of food inflation was unprocessed food prices, which rose by 50.3% on the back of fresh fruits and vegetables (68.8%). Meanwhile, processed food inflation followed a relatively more favorable course, with 37.7%. The annual food inflation fluctuated around 70% in the first half of the year. Leading items of the group were fresh fruits and vegetables, as well as bread and cereals affected by cumulative cost pressures, red and white meat, and processed meat products affected by cumulative increases in meat prices. The downtrend in annual food inflation since June was interrupted in October and November also due to temporary supply conditions in fresh fruits and vegetables amid the transition from field to greenhouse. However, in December, monthly food inflation decelerated on the back of the partial improvement in fresh fruit and vegetable prices, and annual food inflation stood at 43.6% by the end of the year.

Core goods prices rose by 27.4% in 2024, about 17 percentage points below the headline inflation. The annual inflation in core goods, which had been on the rise until May, was affected by wage, demand, and credit conditions. Core goods inflation has been on a downtrend since May, led by weakening domestic demand and easing wage-driven effects, as well as the favorable course of commodity prices. The increase in exchange rate, which remained moderate throughout the year, strengthened slightly in August and weakened again in September. The exchange rate-driven pressures were temporary. The euro rate’s rise in August played a role in accelerating the price increases in durable goods with high exchange rate sensitivity, such as white goods and automobiles. In the same period, the impact of general safety regulations on automobile prices was also apparent. In sum, the moderate course of commodity prices, as well as the real appreciation of the Turkish lira and the weakening of domestic demand conditions, resulted in a decline in core goods inflation in 2024.

In 2024, the highest price increase among main expenditure groups was recorded in the services group with 65.7 percent. Unlike core goods, another component of the core group, services inflation significantly exceeded headline inflation. Despite the decline in annual inflation across subgroups, the inflation in rents and other services was notably high due to the backward-indexation mechanism, wage developments, and structural factors in the housing sector. Rent inflation remained high throughout the year due to the backward indexation in contracts and supply-demand mismatches in the real estate market, mainly driven by the impact of the earthquake. Excluding rents, annual services inflation was lower at 56.8% at the end of 2024. Price changes in the other services subgroup were driven by labor-intensive services items, as well as education services with time-dependent and strong backward-indexation tendencies, while restaurants-hotels inflation was led by demand conditions, food prices, and wage adjustments. Transport services inflation was influenced by seasonal revisions in administered services and fuel price developments. The slowdown in services inflation was more evident in the last quarter.

Energy price inflation, which was well below headline inflation with a 27.2% increase in 2023, ended 2024 at 43.1%, exceeding the previous year’s inflation. This was due to the carry-over effects of the cost pressures from the previous year. In the first quarter of 2024, the course of energy prices was led by fuel and bottled gas prices in line with the developments in natural gas and international energy prices, as well as the automatic tax hikes, while the group’s annual inflation also increased. In May, annual energy inflation rose substantially due to the expiry of the free use of the 25 cubic meters of natural gas for households, as well as the low base effect caused by the free use of natural gas in the same period of the previous year. Domestic energy prices increased significantly in the third quarter amid the developments in taxes and administered items. In July, during the same quarter, the lump-sum SCT amounts on fuel and bottled gas were revised, and electricity and natural gas tariffs for households were raised. Energy prices followed a mild course in the last quarter of the year.

Supply-Demand Developments, External Balance and Labor Market

In 2024, economic activity slowed on an annual basis in line with the monetary tightening-driven rebalancing in demand, and the growth rate stood at 3.2%. The expenditure composition of growth was more balanced compared to the previous year. On an annual basis, economic activity remained robust in the first quarter of 2024, on the back of wage adjustments and the demand brought forward. Additionally, gross domestic product (GDP) rose by 5.4% year-on-year and 1.0% quarter-on-quarter. In this period, the contribution of domestic demand to growth fell, while that of net exports increased (Chart 2.1.2.5). For the first time since the third quarter of 2022, net exports positively contributed to annual growth. On the production side, the services sector was the main driver of growth in the first quarter, with industrial and construction sectors contributing positively to growth. The lagged effects of monetary tightening on economic activity were more evident in the second and third quarters, with annual growth rates recorded at 2.4% and 2.2%, respectively. In the last quarter, annual growth picked up to 3.0%. In this period, domestic demand was the primary driver of annual growth, while net exports had a dampening effect on annual growth for the first time the entire year (Chart 2.1.2.5). On a quarterly basis, GDP registered a slight decrease of approximately zero in the second and third quarters (Chart 2.1.2.6). In this period, the contribution of domestic demand and net exports to growth was more balanced. Meanwhile, household demand was robust in the last quarter of the year driven by sales campaigns and upcoming wage revisions. Against this background, domestic demand contributed significantly to economic growth, while net exports had a downward effect on growth, and the demand composition of growth deteriorated somewhat. Throughout the year, the contribution of domestic demand and net exports was more balanced. Total investments saw robust annual growth in the first quarter, driven by the contribution from the construction and machinery-equipment sectors. However, this growth momentum softened in the second and third quarters, despite the favorable developments in the construction sector. In the last quarter, total investments recovered on the back of the increases in all subcomponents. On the production side, the services sector was the main driver of growth throughout the year, while the construction sector made an upward contribution to growth. In the first quarter of the year, industrial production contributed positively to annual growth in line with the strong domestic demand, despite losing momentum on an annual basis. In the second quarter, the weakening industrial added value due to bridge days over the two religious holidays and the slowdown in domestic demand during the disinflation process had a downward effect on growth. This weak course continued in the third quarter as well. In the last quarter, the industrial sector contributed positively to annual and quarterly growth due to significant increases in production in sectors with a high export share and high volatility, such as the defense industry.

The annualized current account deficit narrowed significantly in 2024 on the back of the decline in the foreign trade deficit and the strong performance in the services balance (Chart 2.1.2.7). Despite the relatively mild course of the economic activity in Türkiye’s main trading partners throughout the year, exports increased year-on-year. This was largely driven by the rise in the quantity, and export prices remained relatively flat. Imports, on the other hand, declined on an annual basis. While imports of consumption goods were strong throughout the year, imports of investment and intermediate goods decreased. However, excluding the jewelry item, which contributes significantly to imports of consumption goods, the annual increase in this sector was quite moderate. The ongoing decline in energy prices had a further favorable impact on the energy trade balance. In line with the ongoing quota on unwrought gold imports and the slowdown in domestic demand throughout the year, gold imports declined significantly compared to 2023. The increase in foreign visitors and net travel revenues had a positive impact on the services balance. The positive contribution of services items to the current account balance further increased. In addition, revisions to the services balance under the 2023 bulletin of the International Trade in Services Statistics, published by TURKSTAT, played a part in the improvement in the current account balance in 2024. This revision had a downward effect of USD 839 million in 2022 and an upward effect of USD 4.5 billion in 2023 on the current account balance.

In 2024, the energy balance made the largest negative contribution to the current account deficit on an annual basis, amounting to USD 10 billion (Chart 2.1.2.8). The robust performance of the services sector contributed positively to the year-on-year change in the current account balance. Additionally, improvements in the gold, energy, and core foreign trade balances supported the narrowing of the current account deficit. On the other hand, the deterioration in the income balance had a widening effect on the current account deficit compared to the previous year. On the financing side, direct investments edged down year-on-year. In the second half of the year, while the equity market experienced outflows, the government domestic debt securities (GDDS) market saw inflows, and portfolio investments increased. However, the weight of short-term items, such as portfolio investments, decreased throughout the year, while the weight of long-term items increased. Meanwhile, in 2024, capital inflows took place predominantly through long-term loans and the bond issuances of the banking and private sectors. Debt rollover ratios of the banking sector were high in the second half of the year, and for long-term loans were around 141% in 12-month cumulative terms at the end of the year.

Key labor market indicators signaled a robust labor market in 2024. The unemployment rate declined on an annual basis (Chart 2.1.2.9). In the first quarter of the year, employment increased on a quarterly basis in all sectors excluding agriculture. In this period, the labor force participation rate also increased, and the unemployment rate stood at 8.8% (Chart 2.1.2.10). In the second quarter, industrial employment declined in line with the weak course of industrial activity, while employment growth continued in the services and construction sectors. In this period, the labor force participation rate edged up, while the unemployment rate edged down by 0.1 percentage points. Despite the loss of momentum in economic activity in the third quarter, the labor market displayed a more resilient performance. Employment increased in all sectors excluding agriculture in the third quarter, and the rise in industrial employment largely offset the decline recorded in the second quarter. The labor force participation rate, the employment growth, and the unemployment rate remained relatively flat. In the last quarter of 2024, the seasonally adjusted unemployment rate decreased to 8.6% on a quarterly basis. Meanwhile, the labor force participation rate displayed a flat course and stood at 54.2% in the same period. Thus, total employment in 2024 increased by 984 thousand people compared to the previous year, while the unemployment rate decreased by 0.7 percentage points to 8.7%. The labor underutilization rate, a complementary labor indicator, increased to 26.7% in 2024. The highest contribution to the rise in labor underutilization rate was made by the increase in the time-dependent underemployment. Meanwhile, the potential labor force increased whereas unemployment declined in 2024.