Oil and commodity prices have continued to soar over the past week, and forecasts for key financial parameters now depend on how long this crisis continues. In a scenario where oil prices remain at their current level – $ 118 a barrel, as are the prices of other commodities, we are expected to see a wave of price increases in the economy. For example, in April the price of fuel will increase by about 7%, which alone will contribute about 0.2% to the price index this month. Subsequently, further increases will be recorded, mainly in transportation prices (flights, public transportation) as well as food prices. In this scenario, in April the annual inflation in Israel will exceed 4%, and it will gradually decrease until the end of the year. In another scenario, where the war ends relatively quickly and oil and commodity prices fall (about $ 90 a barrel), there will still be high price indices in the coming months, but inflation will moderate to about 3% later this year. The length of time that high commodity prices will prevail will affect inflation in the coming year: some prices in Israel, such as flight prices, taxi travel and food products, are gradually updated, and chances are that these prices will not fall even when commodity prices fall in a year. The bond market now embodies high inflation – an average of 3.8% for the next two years, 3.2% for five years and 2.6% for ten years.
The number of employee jobs in the economy continues to rise rapidly – about 86,000 jobs were added in December-January. Looking back two years, the average wage rises at an annual rate of about 4%, this level does not pose a risk to inflation. Although inflation is the result of an exogenous supply market, the Bank of Israel will not be able to resist it. Inflation is a self-feeding process, and under conditions of full employment, the chances of that happening are high. Central banks feel that they are “behind the curve” in adjusting monetary policy, and this was also hinted at in Powell’s testimony, in which he estimated that in order for the economy to continue to expand and create jobs, price stability is required first. That is, the negative consequences of the war in Ukraine on economic activity, are not expected at this stage to slow down interest rate increases. We estimate that we will therefore see the first interest rate hike in Israel as early as April, and the next hike after it is expected to be relatively close. The continued rise in interest rates from this point depends very much on the development of commodity prices and the transmission to inflation.
Why has the ten-year bond yield in Israel become higher than in the US? The war has raised inflation expectations on the one hand, but it is also raising the risk of an economic slowdown. In the United States, ten-year yields declined last week to 1.73%. In Israel, on the other hand, yields rose to 1.9%. Inflationary pressures in Israel are lower than in the United States, and the effect of rising energy prices on inflation is relatively moderate in Israel. We estimate that the explanation stems more from the behavior of US yields – that is, the decline in US yields is a result of investors’ perception of American bonds as a safe haven, at a time when market risks are high, often in isolation from underlying economic data or future monetary policy. Yields in Israel probably reflect a tighter policy over time in light of rising inflation.