The forecast of the research division of the Bank of Israel is abnormal compared to what we are used to seeing in all previous announcements. This time the tone is completely different and much more pessimistic, with the focus being on the far-reaching changes promoted by the government in the legal system.
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The bank expects that in the optimistic scenario, which they define as “in which the controversy surrounding the legislative changes regarding the judicial system is settled in a way that does not affect economic activity”, the interest rate will be 4.75% in a year’s time, and that this year’s growth will be 2.5%. Unemployment will also climb slightly. To put it bluntly, we haven’t seen such a level of interest in almost 20 years. In addition to this, the world is already talking about stopping and even lowering interest rates. Here the direction is reversed.
But what will happen if the negative economic consequences that accompany the promotion of legal reform materialize? The Bank of Israel does warn that GDP will be cut by 2.8% in each of the next three years, but does not explain in detail how it will behave.
This is how the bank’s economists write: “Possible economic consequences to the extent that legal and institutional changes are accompanied by an increase in the state’s risk premium, damage to exports, and a decrease in local investments and demand for private consumption. This scenario is accompanied by higher uncertainty than the standard scenario, regarding the intensity and persistence of the shocks, and therefore the analysis is presented over 3 years as one piece. The forecast shows an indication of the impact on economic developments and its magnitude in the next three years. In the case where the impact of the changes weakens relatively quickly, the damage is estimated at about 0.8% of GDP each year on average over the period of the three years under consideration. In the case where the concept of The public (the financial markets, the real sector and consumers in the economy) will have the effect of the legislative changes persist, the damage is estimated at about 2.8% of GDP per year on average for the next three years.”
The big question that remains unanswered is what the Bank of Israel will do if this scenario materializes. How far will the interest rate rise to cool inflation, and will the bank sell dollars to stop the devaluation of the shekel? There is no unequivocal answer to this.
What the bank is saying is that in the pessimistic scenario the interest rate will rise at an even sharper rate, depending on the extent of the damage. The research division states that the average interest rate throughout the year may be 0.5%-1.9% higher. Quite a broad spectrum. It could be expected that the Bank of Israel would provide the full picture of the threat forecast, and how exactly they are prepared.