First, I will summarize the recent inflation developments, and then continue with the domestic and foreign demand outlook. Annual consumer inflation fell by 7.9 percent in the third quarter of 2013, slightly overshooting the July Inflation Report forecasts (Chart 14). This overshooting was mainly attributed to a weaker Turkish lira and higher unprocessed food prices. As a result, the main inflation indicators increased as well (Chart 15). The higher-than-projected inflation in the previous quarter was largely induced by the additional depreciation in the Turkish lira (Charts 14 and 15). I think it shall be useful to inform you about how the exchange rate assumptions are made in the Inflation Report. Traditionally, the Inflation Report takes the exchange rate realizations during the reporting month as given for the current quarter, and adopts a framework where exchange rates respond endogenously to the monetary stance and other economic developments afterwards. Accordingly, the exchange rate estimations are based on the July average in the July Inflation Report. The Turkish lira depreciated following the July Inflation Report, and this depreciation caused inflation to be higher than projected in the third quarter. This additional depreciation put an upward pressure of about 0.4 points on the end-2013 inflation forecast. Exchange rate developments affect core inflation via prices of core goods (Chart 16). Services inflation went up in the third quarter as well, but remained relatively more stable. Accordingly, core inflation indicators displayed an upward trend (Chart 17).
Hence, a front-loaded monetary tightening was implemented in the same period, which compensated for the distortion in inflation expectations. As of August, we decided to enhance the predictability of the Turkish lira liquidity policy in order to limit the impacts of global monetary policy uncertainties on the domestic economy. To this end, we adopted a strategy of reducing interest rate uncertainty by creating a framework where the relationship between global interest rates and domestic interest rates has largely weakened and market rates have become more sensitive to domestic macroeconomic developments as they should be. BIS central bankers’ speeches  1  In the third quarter, we continued to provide the market with foreign exchange liquidity via foreign exchange selling auctions, which fed into the growing Turkish lira liquidity deficit in the market (Chart 3). We cut the share of one-week repo in total funding in this quarter, which led to an increase in the share of funds from overnight and monthly lending facilities. Correspondingly, the CBRT’s average funding rate and the BIST interbank overnight repo rate increased (Chart 4). Moreover, in line with its strategy of enhancing the predictability of liquidity management, we have been sharing more information about the frequency and timing of the additional tightening since August. Recently, due to our cautious monetary stance, the Interbank Repo Market rates have been mostly hovering between 6.75 and 7.75 percent.