The author is the chief economist of Mizrahi Tefahot Bank
The Bank of Israel could not have asked for a more favorable timing for raising the interest rate in the economy, for the first time since November 2018, from 0.10% to 0.35%. Even the capital markets could not have received a more convenient message. In fact, with the exception of the interest rate itself, which surprised us most, we “chose” between an interest rate of 0.25% and an interest rate of 0.50% (as we are used to).
The Bank of Israel reassured investors on two key points:
One, inflation, which seems to have become the face of everything in recent months. Yes, it’s going up. Yes, it does require care. No, she’s not entertaining. No, it’s not in the inflation league in the US and Europe, where you play with unfamiliar territory of 8%. No, it will not go too far from the target ceiling, 3%.
In fact, the inflation that the Bank of Israel forecasts for 2022, 3.6%, is similar to that recorded in the last 12 months, 3.5%. And if we just wait a bit, then next year we’ll already be back to 2% inflation and a foreigner who gets caught here will not know that the economy, like the rest of the world, has been experiencing a sea of upheavals in the last year or two.
The second point: the interest rate will rise, but in relation to its current level, 0.35 percent, it is only an increase of 1.15 percent, which is 5-4 increases. The most interesting question is whether a return to multiples of 0.25 percent will be made by a single increase of 0.15 percent (so I think) or of 0.4 percent (see no reason for this).
Encouraging data
Now, let us remember three background factors that make the move taken by the Bank of Israel and the horizon that the research department’s forecast drew even more favorable:
One, despite the rising interest rate, the GDP growth rate this year will remain 5.5% and only next year will slow down a bit (which would have happened, in my opinion, even if the interest rate had not risen).
Second, it’s a little hard to believe, and OECD economists probably did not imagine, but the labor market also soared, unemployment fell to 3.2% and the term “full employment” again befits it.
Third, the unusually low budget deficit, 1.4% of GDP, which any reformed country will be proud of, and which was certainly one of the main factors in Moody’s’s announcement of raising the economy’s rating outlook, actually reflects a restrained budgetary policy and allows the Bank of Israel to raise interest rates (Certainly more measured than is true for the US and later, perhaps, for the eurozone as well).
This state of affairs will also prevent a re-appreciation of the shekel against the dollar. It is not for nothing that the Bank of Israel bothered to acquire $ 30 billion (at least) last year and it is clear that it will not want to have to make such an unusual move this year as well.
As for the housing and mortgage markets, raising measured interest rates will moderate the increase in debt service spending in this important sector for borrowing households, and may also ease the pressure of demand on the housing market.
Critical questions
Right. There are quite a few risk factors today. Will the war in Ukraine end soon, as well as the consequences of the corona, so that the reduction in supply pressure on the supply side, on which the Bank of Israel is building, will indeed occur? Will the latest political developments allow the budgetary environment to remain so comfortable (a significant point for the Bank of Israel and the rating agencies)?
If the answers to these two questions are positive, then the process of normalizing interest rates that the Bank of Israel began today will be smooth and will correspond well with the successful way in which the economy has faced its various challenges in the past two years.
A relatively measured route of raising the interest rate here, together with the government’s particularly low capital raising needs, will work in favor of the local bond market and counterbalance the negative effect of rising inflation on the unlinked shekel channel, an effect that also does not appear to be strong. Too, given the Bank of Israel’s new inflation forecast.
In addition, the consumer price index for March will be published on Friday. According to current estimates, the annual inflation rate will rise slightly, to 3.7%. I have a vague feeling that the Bank of Israel would like to include the figure in its set of considerations and its leaders hope that it will not be surprising upwards. For Powell and his friends at the Fed this has been happening again and again in recent months. But this is the “price” of moving from 12 monthly interest rate decisions to just 8.
We hope that even after the index we can wish each other a happy holiday. Will inflation really “align” with Bank of Israel forecasts? It’s seen after the holidays.