So far, the second round impact of food prices has been limited and confined to selected sub-components of the overall index such as restaurants and catering services. The potential second round impact of elevated food and energy prices, however, on overall economy should not be overlooked. Therefore, the CBRT will keep a close eye on the price setting behavior along with various core inflation measures. In the upcoming period, the Central Bank will tolerate the first-round impacts on inflation resulting from food, energy and one-off adjustments in administered prices, yet remain responsive to the second round effects such as possible deterioration in general pricing behavior. The Central Bank closely monitors the developments in global markets. The potential impact of ongoing difficulties in the US credit markets, on the financial markets and the real economy, continue to create uncertainty about the course of the global economy. Our baseline scenario assumes a soft landing in developed economies, with no major portfolio shock on the Turkish financial markets. However, the probability of a sharper than expected slowdown should not be ruled out. While the possibility of a sharper-than envisaged slowdown in global economic activity, through its potential impact on the exchange rates, may constitute an upside risk for the short term inflation outlook, it also poses downside risks for inflation in the medium term through a possible weakening in external demand and domestic credit.
This observation shows that inflation target, to a significant extent, continue to serve as an anchor and that economic agents expect the disinflation process to continue in the medium term. Nevertheless, the fact that currently medium-term inflation expectations are significantly above our medium term target of 4 percent necessitates a cautious policy stance 1 . Figure 10: Medium-Term Inflation Expectations* 9 12-Month  24-Month  8  7  6  5  0108  1107  0907  0707  0507  0307  0107  1106  0906  0706  0506  0306  0106  1105  0905  0705  0505  0305  0105  4  Expectations regarding the period after 24 months have been published since May 2006. Source: CBRT. 1  As of January, one-year and two-year ahead inflation expectations are 6.01 percent and 5.17 percent, respectively. BIS Review 20/2008  7  3. Inflation and monetary policy outlook  Distinguished Guests and Press Members, After summarizing inflation and monetary policy developments in 2007, in this part of my speech, I would like to share our evaluations on inflation and the monetary policy outlook. First of all, I would like to summarize several factors that might enable the disinflation process to continue in the upcoming period: Annual percentage change in CPI excluding food, energy and tobacco imply an inflation trend of 4.8 percent (Figure 11) 2 . In other words, underlying inflation in the past year was not far away from the medium-term targets.