Türkiye's central bank chief said Wednesday that a clearer slowdown in domestic demand and fading shocks would let disinflation regain momentum, stressing that policymakers would remain cautious to preserve gains achieved in lowering inflation.

Annual consumer price growth eased more than expected to 29.73% in September from 31.51% in August, official data showed Monday. That marked the first time inflation dipped below 30% in almost five years.

Inflation had peaked at 75.5% in May 2024 and has fallen substantially since, although the downward trend stalled earlier this year following a sharp rise in energy prices caused by the Iran war.

The Middle East conflict that began in February pushed up commodity prices, especially for energy, raised transport costs and disrupted supply chains.

That has caused global growth to weaken and inflation to rise, Central Bank of the Republic of Türkiye (CBRT) Governor Fatih Karahan said.

Underlying trend points lower

Policymakers at the central bank are particularly looking at underlying trend indicators, Karahan told an event in Istanbul.

Three-month averages pointed to a rising underlying trend between March and June, when the war's effects were most visible. The trend has declined again since July, he said.

On an annualized basis, he said, the underlying trend, which rose to around 30% during the war, stood at 23.7% in September, about 6 percentage points below the current annual rate.

Karahan said this suggests disinflation will speed up if supply-side pressures fade, and he credited the tight policy stance's effect on demand and pricing behavior.

Energy the exception

In September, annual inflation was lower than a year earlier in every category except energy.

Annual energy price increases reached 46.1%, about 11 percentage points above last year's level, said Karahan, describing it as the main reason disinflation lost pace.

In services, annual inflation fell by 7 percentage points to 37.%. Monthly rent increases, which had long run well above services inflation, have slowed noticeably in recent months and are now below the services average. Karahan said this shows inertia from rents is weakening.

Annual inflation in the food and nonalcoholic drinks category fell to 27.6% from 36.1% a year earlier, helped by a recovery in agricultural output after last year's adverse weather. Karahan said the bank is watching global agricultural prices and climate risks closely.

In core goods, Karahan said annual inflation fell to 15.9% from 19.9%. He added that moderate core goods inflation, despite cost pressures, indicates weak demand is limiting the pass-through of costs.

He noted some upward pressures. Education services inflation slowed from a year earlier but ran higher than expected after September increases. Transport services inflation was 44%, above the previous year because of the indirect effects of higher energy prices. Communications services inflation jumped to 44% from 24%.

Some analysts said the September inflation reading raises the prospect of an interest rate cut at the Oct. 22 meeting.

The bank has kept its benchmark one-week repo rate at 37% this year, as it monitored ‌the inflation impact of the Iran war.

Weak demand, but expectations a concern

Karahan said first-half national income data and indicators for the third quarter point to weak domestic demand. Excluding gold, retail sales growth slowed in the third quarter, he said, and limited growth in quarterly card spending also confirmed the slowdown.

Inflation expectations have not improved as the bank had forecast at the start of the year, which Karahan said remains a risk to disinflation and requires continued caution.

Early in the war, the bank had said the effect on the medium-term outlook would run through two channels: a possible deterioration in expectations and a cooling of economic activity. Karahan said that, thanks to the tight stance, deterioration in expectations has been limited, while weaker demand has pushed the underlying trend lower.

Reserves and current account

Karahan said the current account deficit narrowed in the second quarter despite adverse external conditions and remained roughly flat as a share of national income. He said high energy prices carry upside risk for the trade deficit, but the bank expects this year's current account deficit to come in below its long-term average relative to national income.

He said gross reserves, which stood at $210 billion (TL 10.33 trillion) in late February, fell to $149 billion at the end of June under the war's impact, before rebounding to $171 billion by the end of September.

Of the decline since February, $23 billion was due to the fall in gold prices, Karahan said. Net reserves excluding swaps were about $40 billion as of the end of September, he added.