The aggressive policy of raising interest rates in Israel has given its signals. The Bank of Israel raised the interest rate for the seventh time in a row, this time by half a percentage point to 3.75%, which is the highest interest rate since 2008. The goal is to fight inflation (after all, no one wants to reach a situation of double-digit inflation – meaning that within a year NIS 100 becomes NIS 80, for example).
“High inflation will make it difficult to slow down the rate of interest rate increases,” says Ofer Klein, head of the economics and research department at Harel Insurance and Finance, who believes that the Bank of Israel’s forecast for 2024 is too optimistic. Rafi Gozlan, Chief Economist of IBI Investment Bank, even believes that the high inflation environment may make it difficult to slow down the pace of interest rate increases.
Klein says that the high inflation (5.3% in November), the strong labor market and the continued interest rate hikes in the world contributed to the decision. He adds that the governor signaled that the process of raising the interest rate has not yet ended (in contrast to what has recently been embodied in the bond market) and noted that in-depth analyzes done at the bank show that a large part of inflation originates from local demand. In the next decision on February 20th, and we do not guarantee that this is the end of the story, if inflation and the economic indicators surprise upwards in the future.
At the same time, he explains: “The bank has slightly updated the growth forecast for 2023 downwards to 2.8 percent (our forecast is slightly lower at 2.5%) in light of the expected lower growth of our main trading partners. In the inflation and interest sector, the bank does not expect inflation to will return to the inflation target limit (3%) until the last quarter of the year and at the same time does not see an interest rate cut during the year. (We agree with these two forecasts). In addition, for the first time the Bank of Israel published a forecast for 2024 according to which the economy returns to growing at a rate close to its long-term potential (3.5%) and the unemployment rate remains unchanged (4%). It should be noted that this forecast is optimistic in our eyes and we see a lower growth rate and a higher unemployment rate against the background of our belief that the restraining processes will continue (even with less) during the first half of 2024.”
He further claims that “the bank’s forecast for the government deficit of around 2 percent in 2023-2024 is interesting. We believe that this is possible in 2023 (due to the lack of a budget in the first months of the year) but due to the coalition agreements the forecast is less likely in 2024 (and a higher deficit supports higher inflation and higher interest rates)”.
“Bottom line: we start the year 2023 with an interest rate that is significantly higher than what we have become accustomed to in the last decade and in the bank’s assessment (and we agree with this) it will also remain so during the year. The effect of the interest rate will translate into damage to economic growth and an increase in the unemployment rate (which we believe will continue into 2024). On the side The positive thing about savings and investments is that we can expect to receive a more attractive interest rate.”
He believes that the lowering of the tax on the sugary sediments and the disposable utensils will be divided between the retailers and the consumers. “The Finance Minister’s announcement of his intention to cancel the levy on disposable utensils and also the excess tax on sugary drinks will cumulatively reduce about 0.15 (and a maximum of 0.2) percentage points from the forecast for the January/February indices (depending on when it will actually be realized). When these taxes came into effect ( January 2022 and November 2021) they increased the index cumulatively by about 0.25 percentage point, but we believe that not all of the reduction in taxation will return to the consumer. The forecast for the next 12 indices remains at 2.8 percent (due to the devaluation of the shekel), but there is a chance of a downward surprise if the government You will also freeze/moderate the increase in the price of electricity, water and property taxes.”
Gozlan emphasizes several other issues. “The tone of the announcement was balanced so that alongside the high inflation and the tight labor market, the committee indicated signs of moderation in these parameters. However, within the announcement and the press conference, a clear warning sign was placed for the incoming government regarding the importance of maintaining fiscal discipline, especially at a time when the economy is heating up,” he explains . “It seems that the governor adopts the Fed’s line by stating that the current policy is already restraining, that the next decisions will depend on the data while taking into account the lagging of the monetary policy, and that the interest rate is expected to remain at a high level until there is a high degree of confidence in the decrease of inflation towards the target.”
Gozlan claims that the high inflation environment and uncertainties regarding the intensity of the decrease in inflation in the future, may make it difficult to slow down the rate of interest rate increases and we expect the interest rate to be increased to 4.5%-4.25% in the next 2-3 decisions. Also, if the path of interest rates later this year has depended so far mainly on global developments, and in particular on the path of interest rates and inflation in the US, then today the local fiscal policy poses an upward risk to the inflation and interest rate forecast.
“The Monetary Committee announced another increase in the interest rate in accordance with the consensus assessment and our assessment, but higher than the pricing in the market which ranges from an increase of 25 to 50 bps. The future direction remains unchanged, and includes an expectation of continued interest rate increases depending on the data. Beyond that, the tone of the announcement was relatively balanced, so that in addition to referring to the environment of high inflation, the high level of activity in the economy and the tight labor market, the announcement also indicated a certain moderation in these parameters. Thus, the committee continued to point out that the increase in inflation continues to be broad, including an increase in basic inflation, but indicated a moderation in the rate of increase in the tradable goods index.
Gozlan points out that the committee’s comments, that the labor market continues to be tight, but indicated a certain moderation in the latest employment data. “Similarly, the committee noted that the economy continues to be characterized by robust economic activity, but a certain moderation is noted in the final data, that is, a slowdown in the growth rate. In terms of global activity, the pessimistic tone continues, and the committee noted that the risk of a recession is increasing, while on the positive side, the committee noted the moderation in inflation, Although its level is still high,” he concludes.
“During the press conference, the governor continued to convey the determination required by the monetary policy to lead inflation back to the target. Also, it appears that the bank is adopting the Fed’s line, so the governor indicated that in his assessment the current policy is already restraining (against a rise in interest rates) the realism for positive territory), and that the following decisions will depend on the data while also taking into account the built-in lag of the effect of the monetary restraint so far. Also, the governor directed the interest rate to be allowed at a relatively high level for a certain period of time until there is sufficient certainty regarding a decrease in inflation towards the target.”
“As expected, the research department’s updated forecast included a downward revision to the growth forecast and an upward revision to inflation and interest. The growth forecasts for 2022 were updated from 6% to 6.3%, and the forecast for 2023 was updated downward from 3% to 2.8% , mainly due to the downward revision of exports and public consumption compared to the upward revision of private consumption and imports. This forecast includes an increase in average unemployment (ages 25-64) from 3.2% to 4% in 2023. Also, the inflation forecast for 2022 was updated from 4.6% to 5.2%, while the forecast for 2023 was updated from 2.5% to 3%. The forecast for interest in one year was also updated from 3.5% at the end of the third quarter, to 4% at the end of 2023.”
“The research forecast includes a certain and moderate increase in wages in the public sector and partial implementation of the coalition agreements, and these are expected to lead to an increase to a deficit of at least 2% of GDP in 2023-2024. Both the announcement and the governor at the press conference emphasized the importance of fiscal discipline, and placed a warning sign For the incoming government not to adopt an overly expansionary policy, because especially at this time when the economy is heated, this will quickly lead to an increase in the inflation and interest rate environment.”
“The message that emerges from the announcement is to continue raising interest rates with the possibility of slowing down the pace, but in our estimation the inflation data may make it difficult for the bank to slow down the pace. Indeed, there is a certain lag between inflation in Israel and the US and in our estimation the moderation in local inflation will arrive about two quarters behind the US , so that inflation will drop from 5% only in the second quarter of the year and from 4% only in the third quarter of the year,” he concluded. “Also, the expected acceleration of interest rate hikes in the Eurozone and a significant probability of an increase of 50 basis points also in the US in February may also make it difficult for the bank to slow down the rate of increase, so the transition to a more moderate rate may be postponed until a decision in April.”