Large variation within inflation forecasters

Large variation within i

November 5, 2009 16:48
3 minute read.

Inflation Report: Bank of Israel (BoI) published yesterday the inflation report of the third quarter. The CPI (Consumer Price Index) rose by 1.3 percent in the third quarter, whereas between April and August it had risen at an annual rate of 9 percent!! The sharp price increases were mainly due to government policy measures, primarily an increase in the VAT and a temporary surcharge on water prices in light of the drought. In addition, the increases in the housing component significantly contributed to the high readings in the past months. Compared to the previous inflation report the price zone looks in a better shape. In December 2008 inflation expectations for the next twelve months derived from the capital market were of a negative 0.7 percent, deep below the central bank's target range of 1-3 percent annual rate. In the third quarter this phenomenon reversed and average expectations returned to close to the upper limit of the target range. More recently, inflation expectations have declined to 2.2 percent, close to the target range midpoint. High level of Dispersion: Generally, the last inflation report does not provide any significant new information, but it does present an interesting phenomenon: a large disagreement within the corporate world regarding the future inflation. In other words, there is a high level of dispersion with regard to inflation forecasts among the forecasters. The rate of inflation in the next 12 months according to market forecasters is expected to be near the mid-point of the Boi's target range (2 percent). Due to the economic and market recoveries, most of the financial institutions increased their forecasts, however the variation remained high. Some institutions estimate an annual inflation of 1 percent 1 year ahead while other institutions predict readings high above the 3 percent level - which represents the upper limit of the central bank's target range. According to the quarterly Businesses Survey which was published recently, the annual inflation average forecast is 3.2 percent. 47 percent estimated that the inflation will be above Boi's range, 51 percent believed that the inflation 1 year ahead will be within the range, and only 2 percent believed that it will be below the range. As opposed to the first two, Boi estimate lower inflation. According to its quantitative model the annual inflation will moderate in the next year to as low as 1.2 percent. The model's results are based on several assumptions and forecasts. Firstly, Boi forecast that international trade activity will decrease by 14 percent in 2009 and will return to growth in 2010. Also, it estimates that the global stagnation and credit deleveraging will continue to be a burden on the real economy. Moreover, the bank does not expect any inflation pressures from the labor market, and sees factors that support a continuous appreciation of the Shekel. Inflation in the near future: The Israeli CPI is forecasted to remain unchanged in the October reading which will be announced on November 15th. Contributors to this rise will be housing prices, as well as a seasonal rise in clothing and footwear prices, as winter items enter the stores, combined with a moderate rise in food prices. Price reductions were recorded in fruits and vegetables, contrary to their seasonal behavior. Furthermore, gasoline prices dropped by 2.1%, and external tourism also declined. November CPI is expected to rise by 0.2%. The reading will be affected by clothing and footwear prices and a rise of fresh produce prices. Fuel prices are expected to rise as well due to continued increase of the oil and other energy prices. These increases will be partly offset by a drop in the transport and communications prices, due to the seasonal decline in the prices of travelling abroad and a drop in water prices as a result of an increase in the allotments. Currently, the forces that support a decrease in prices overpower the forces that support an increase in overall consumer prices. Prices are expected to go down in the next 12 months. However, investors should not ignore the prices' uplifting forces such as the increase of commodities prices, the real economy recovery, and the inflationary monetary and fiscal steps that were taken in the last 2 years to help reviving the global economies. The writer is Chief Analyst and Strategist at Alumot-Sprint Investment House and also a regular writer for several leading financial papers and websites

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