Inflation expectations 1 week ago (red) vs. current expectation (blue) ..
(photo credit: none)
The central Bank of Israel (BoI) will announce on
Monday its decision regarding the monetary policy for the month of
September. The bank is expected to leave the interest rate unchanged at
the record low level of 0.5% for a sixth month. The main considerations
behind the decision would be the uncertainty regarding developments in
the global economy, the fact that major central banks keep interest
rates low, and estimations that output gap and unemployment will
moderate price pressures.
Continuous Rising Prices Supports Tightening
However, according to market indicators, the
current benchmark rate is not compatible with the current situation of
Israel's macroeconomic environment. BoI cannot wait too long as other
central banks and should start its tightening campaign mainly due to
domestic inflation pressures.
In the past 12 months, the Consumer Price Index rose by 3.5%
despite the global recession and the negative implications on the
export sector. In the past 5 months prices rose by almost 4% primarily
as a result of rising housing and energy prices which are estimated to
keep rising in at least the next six months.
Economists forecast that the inflation over the next
12 months will range between 2.5% and 4%, while the capital market
priced even a higher level of 4.2% a week ago. In the past few days,
the inflation expectations that are derived by the bond market have
decreased from 4.2% to 2.5% (12 months forward) due to estimations that
BoI will increase rates sooner than previously expected.
Recent economic indicators
support the assessment that the domestic economy is emerging from the
recession and relatively immuned to the external shocks. Hence, BoI
should be less expansionary driven. Israel's economy expanded 1 percent
in the second quarter and expected to rise also in the current one. The
composite state-of-the-economy index rose by 1.2 percent in July -
second month in a row, after declines in the index every month since
June 2008. The rise in the index this month resulted from an increase
in economic activity in all categories, and in particular from steep
increases in manufacturing production and trade and services revenue.
Additionally, the Israeli Employment Organization reported a decrease
of 2% in unemployment claims in July.
Need to raise, but will keep unchanged:
Market is pricing in the probability of a beginning of rate hikes by
the end of the year. Nonetheless, some economists estimate that BoI
might and should raise the benchmark rate already on coming Monday due
to the reasons mentioned above.
The uncertainty is high. Increased confidence that the domestic
recession is ending clearly is not enough to execute a shift in
monetary policy. First, there continues to be considerable uncertainty
about the strength of the recent trends. Second, banking lending
remained relatively weak. And if growth slows again inflation might
fall. BoI announced recently that it expects increases in the CPI
(consumer price index) in the months of July and August, mainly because
of the increases in VAT (value added tax) and government-supervised
prices, but the bank also predicted a decrease in inflationary
pressures later this year. Therefore, the governor Stanley Fischer
might hold rates at record low for at least another month and examine
the economic developments and prices dynamics.
The writer is Chief Analyst and Strategist at Alumot-Sprint Investment House and also a regular writer for several leading financial papers and websites