The fall in the last quarter of 2010 would reflect the base effects caused by the indirect tax hikes and the sharp increases in food prices that occurred during the last quarter of 2009. Similarly, the impact of the tax hikes, which added around 1.9 percentage points to headline inflation in the first quarter of 2010, would largely disappear during January and February of 2011. Accordingly, inflation would fall to 8.4 percent at end-2010, and display a significant drop during the first quarter of 2011, converging to levels consistent with the targets (Table 3). Afterwards, with the transmission of the lagged impact of the envisaged monetary tightening, inflation is expected to further decline and stabilize at around 5 percent over the medium term. The projection that inflation would remain at elevated levels – albeit temporarily – over the forthcoming period, highlights the importance of expectations management. As of April, medium-term inflation expectations are significantly above the revised inflation forecasts (Table 3). In this respect, it is critical that economic agents, with an awareness of temporary factors, focus on medium-term inflation trends, and therefore, take the inflation targets as a benchmark for their pricing plans and contracts. At this point, I would like to emphasize once more that any new data or information regarding the inflation outlook may lead to a change in the monetary policy stance. Therefore, I would like to particularly highlight that assumptions regarding future policy rates underlying the inflation forecast should not be perceived as a commitment on behalf of the CBT. 4.
However, owing to the effects of tax hikes, increases in food and energy prices, and base effects, the inflation rate is hovering significantly above the target, which is having an adverse impact on inflation expectations, and leading to risks regarding pricing behavior. Therefore, the revised forecasts are based on the assumption of gradually withdrawing the excessive amount of liquidity provided to the market, and increasing policy rates at a measured pace starting in the last quarter of 2010. However, based on the prediction that resource utilization will likely remain at low levels for sometime, the baseline  scenario envisages that the increases in interest rates would be limited with policy rates remaining at single-digit levels throughout the forecast horizon. As shown in the slide, inflation will follow a volatile path throughout 2010 owing to the base effects driven by the temporary tax cuts and unprocessed food price fluctuations that occurred during 2009 (Figure 34). The temporary tax cuts implemented in March 2009, which were withdrawn partly in June and fully in October, would cause headline inflation to increase during March and April, and to decrease during June, July and October of 2010. Accordingly, inflation is expected to increase slightly during the second quarter and then fluctuate at around 10 percent in the third quarter (Figure 34). Inflation is expected to drop significantly in the last quarter of 2010 and the first quarter of 2011 (Figure 34).