Monitoring Turkey: Softening in Economic Activity

Why It Matters

The growth slowdown and stubborn inflation jeopardize Turkey’s disinflation roadmap while a widening external deficit strains foreign‑exchange reserves and puts pressure on the lira, limiting policy flexibility.

Key Takeaways

• Q1 GDP 2.5% YoY, net exports drag -0.7 ppt.
• May inflation 32.6% YoY, core CPI 30.4% YoY.
• Policy rate around 40%, macro‑prudential loan caps tightened.
• Current account deficit $9.7bn March; reserves fell $43bn.
• TRY projected at 53 per USD by year‑end.

Pulse Analysis

Turkey’s early‑year slowdown reflects a shift from the robust domestic demand that powered growth in late 2025 to a more fragile external environment. Net exports turned negative, erasing 0.7 percentage points of GDP, while capital formation also retreated. Services still provided the main boost, but industry and construction offered little support, leaving quarter‑on‑quarter growth at a meagre 0.1%. Analysts now see annual growth hovering around 3%, a modest figure that underscores the economy’s sensitivity to trade dynamics and geopolitical shocks.

Inflation continues to dominate policy discussions, with May’s headline rate edging to 32.6% YoY and core CPI at 30.4% YoY, driven by food, processed goods and transport costs. The Central Bank of the Republic of Turkey (CBRT) has kept the effective funding rate near 40% and introduced tighter macro‑prudential limits, cutting retail overdraft caps from 2% to 1% and modestly reducing SME loan caps. These measures aim to curb credit expansion and support the disinflation agenda, but the high policy rate also risks dampening consumption and investment, creating a delicate balance for policymakers.

External balances present the most immediate headwind. A $9.7 bn current‑account deficit in March pushed the 12‑month deficit to $39.7 bn, while official reserves fell by a record $43 bn, leaving the foreign‑exchange buffer thin. Despite a narrowing trade gap in April, the broader deficit trajectory remains negative, prompting market participants to price the Turkish lira at around 53 per USD by year‑end. Sovereign bonds have gained a modest discount relative to regional peers, offering a 45‑bp spread over BB‑rated issuers, yet the lingering reserve depletion and geopolitical uncertainty keep the risk premium elevated.