(photo credit: Bloomberg)
In response to the sensational GDP figures published on Wednesday, showing that
the Israeli economy grew at an annual rate of 7.8% in the fourth quarter of
2010, Citigroup Global Markets analysts David Lubin has produced an updated
assessment of likely Bank of Israel monetary policy.
Because growth is
being fueled by domestic consumption, Lubin estimated that the central bank
will need to raise interest rates and allow the shekel to strengthen in order to
keep inflation under control.
“It’s been clear for some time that Israel
has some of the characteristics of an ‘Asian tiger’ and the fourth quarter GDP
data seem to support that idea. Israel boasts a number of features of
better-known Asian success stories further to the east. It is highly open
(exports are over 40 percent GDP); it enjoys a current account surplus and very
low levels of foreign debt (in fact, it is a net foreign creditor); its success
is based on an impressive technology sector; and it grows. Q4 GDP rose by a
seasonally adjusted 7.8% annualized over the quarter, way above the market’s
4.2% forecast,” Lubin wrote.
However, in one very important respect,
Israel differs from the Asian tigers.
“But while the rate of Israel’s
growth seems ‘Asian tigerlike,’ the composition of that growth isn’t: Israelis
like to spend,” Lubin continued.
“All this is consistent with the one
area where Israel’s economic fundamentals depart from their East Asian
counterparts: savings. Asian tigers have a much stronger savings culture than
Israel’s saving/GDP ratio is closer to 20% than the 30%+
that many Asian economies enjoy.
“The strength of domestic spending
within the GDP data will give the Bank of Israel pause for thought: monetary
policy needs tightening through rate hikes and stronger shekel. While it is
possible that these GDP data could be revised down, the idea of a strong Israeli
consumer makes intuitive sense: real interest rates are exceptionally low, a
recession was avoided in 2009, confidence is high and the shekel is relatively
strong in real terms. And strong domestic spending growth may help explain a
3.6% year-on-year inflation rate in January which, like the GDP data, came out
higher than almost everyone’s expectations,” said Lubin.
question confronting the Bank of Israel is this: are the bank’s interventions in
the FX market helping to erode the credibility of its commitment to the
inflation target? Since this question is in the air, and since growth seems very
strong, we think the Bank may lean towards allowing more shekel appreciation
over the next few months,” Lubin concluded.
“A combination of decisive
rate hikes and a stronger shekel could both be needed to keep inflationary
expectations under control, in our view.”