Economy's turning point is just around the corner, says Fischer

Consumer prices to increase over next two months as taxes rise.

fischer 248.88 (photo credit: Ariel Jerozolimski)
fischer 248.88
(photo credit: Ariel Jerozolimski)
Governor of the Bank of Israel Prof. Stanley Fischer said Thursday that a significant portion of the economy was expected to return to growth by the end of the year while unemployment will continue to rise. "We have passed the worst of the financial crisis, but the crisis in the real economy is still with us. We have not reached the turning point, but assessments are for the second half of this year or the first quarter of next year," said Fischer on Thursday in Eilat at the 17th Annual Caesarea Economic Forum organized by the Israel Democracy Institute. "Initial indications of the central bank's companies' survey for the second quarter show that several industries believe they will start to grow by as soon as the third quarter of the year, so that we may see growth before the end of the year. However, it is clear to us that unemployment will continue rising, because that is what always happens at the end of a recession and at the beginning of a recovery." Economists expect the rate of unemployment to increase to between 8% and 9% by the end of the year from the current 7.8%. Fischer added that the survey showed that the decline in business activity in the second quarter was smaller than in the first quarter. Fischer forecasted that prices will increase over the next two months as a result of the government's decision to raise value-added-taxes and other taxes. "Expansionary monetary policy around the world has in recent months raised concerns about inflation. In Israel we have another reason to be concerned about inflation as prices are set to rise over the next two months because of the increase in VAT and water prices," said Fischer. "If the changes in price levels trickle to the rest of the economy we will need to address it. Our aim is to get inflation back into our price stability target range of around 2 percent within a year." On July 1, VAT on goods was raised from 15.5 percent to 16.5%. As a result of the VAT hike and the increase in water prices, Bank Hapoalim economists expect the consumer price index for July to rise by 0.7% compared with an expected 0.5% rise in the June index. Fischer said that the central bank's monetary expansion has reached its limit and increased government spending would now play a key role in the country's economic recovery. "We can't expand monetary policy any further than we already have," said Fischer. "We will get a pretty big fiscal boost, and this is very positive." The central bank, which has cut rates by 3.75% since October to a record low of 0.5% as it sought to revive an economy that shrank at a 3.9% pace in the first quarter, is expected to leave interest rates unchanged next month. The government is expected to increase spending by about 6% in the second half of the year when it passes its 2009-2010 budget spending plan in the middle of this month. Also speaking at the economic forum, Prof. Jacob Frenkel, chairman of the G30 Group, said that the recovery of the world crisis still had a long way to go. "There is still a long way for the world crisis since there are time bombs that did not go off yet - commercial real estate, credit cards - although the saving rate in the US has started to grow," said Frenkel. Commenting on the controversial new Bank of Israel Law, Fischer said that the passage of the law would enable the central bank to work more efficiently opposite the Treasury without the frictions present in previous years. "The law will clearly define the objectives of the central bank and create a monetary policy committee to make decisions on interest rate policy," said Fischer. On Sunday Prime Minister Binyamin Netanyahu and Finance Minister Yuval Steinitz are expected to submit a draft of the new Bank of Israel Law, which is aimed at strengthening the independence of the central bank, to the cabinet for approval. The decision to submit the central bank reform law comes after last week Netanyahu was forced to intervene to settle a bitter dispute over supervision of Bank of Israel wages between the finance ministry and the central bank, which blocked the reforms from moving forward. Under the terms of the settlement, wage supervision will remain under the responsibility of the Treasury while the central bank will be able to appeal decisions through an independent committee. Fischer had sought to take the responsibility out of the hands of the Treasury. "We reached a compromise which is relatively fair. It neither makes me happy nor the Finance Ministry, but that is the nature of compromises," said Fischer. (Bloomberg contributed to this report)