The Bank of Israel is expected to announce the level of interest rates in the economy on Monday, after two interest rate hikes at previous Bank meetings this year and when inflation exceeds the target set by law. In addition to inflation threats and fears of a slowdown, joining the list of risks is the dissolution of the Knesset. But political instability is nothing new for the Israeli economy and the Bank of Israel believes that the economy knows how to work well under conditions of political uncertainty, as Governor Amir Yaron said last week at the Eli Horowitz Conference on Society and the Economy.
Along with the interest rate announcement, the Bank of Israel will publish the Research Division’s forecasts for inflation and growth. In the previous update in April, the research division jumped sharply (2%) the inflation forecast. Director of the Research Division Michel Strawczynski explained this this week in a surprising jump in the rate of inflation resulting from Russia’s invasion of Ukraine in February. This time, the research division is expected to lower its growth forecast for the economy after a surprising contraction in GDP by 1.9% in the first quarter. As a rule, raising interest rates during a period of slowdown does not benefit the economy.
To this must be added the political instability created with the dissolution of the Knesset and the gloomy forecasts for the world economy. All of these do not support raising interest rates, which will further slow down the economy. On the other hand, the tight labor market and the improvement in private consumption, along with global interest rate increases, support a sharp rise in interest rates in Israel as well.
The Bank of Israel is not worried about a slowdown in high-tech
After a bonanza year in high-tech in 2021, in 2022 there is a slowdown in the value of companies in the industry – which plunged by tens of percent in almost perfect proportion to the fall in the US Nasdaq index. From breathable air at least until rage passes.
Fears of a slowdown in the economy as a whole and in the high-tech industry, especially against the background of a cloudburst in the global economy and the upheaval in the financial markets, support a moderate rise in interest rates in the forthcoming announcement. But the Bank of Israel is not worried and sees the high-tech industry as more resilient compared to previous crises, such as that of 2001 – the dot.com crisis. “The high-tech sector is inherently prone to slowdown and volatility in the markets but it has greater resilience than we have seen in the past. In dot com we have experienced greater damage to GDP than to Corona,” said Governor Yaron last week.
Expectations are approaching the peak of inflation
When determining the level of interest rates in the economy, the Bank of Israel will take into account the inflation data that continued to climb in May to 4.1% – above the target range of the central bank, but below forecasts and in a good place from below compared to developed countries. But core inflation (inflation neutralizing food and energy) is already beginning to resemble that prevailing in the world. However, the tax cuts on fuel that have been made so far have contributed to a drop in inflation expectations and these are now anchored within the target range (1% to 3%) and the peak may be behind us. According to forecasts, inflation will converge to the target range in the second half of 2023.
Where will the Bank of Israel place the emphasis in the forthcoming announcement? According to Bank Hapoalim economists, “the convergence of inflation expectations into the target range is a very positive development for the Bank of Israel, but it should be remembered that expectations converged on the assumption that interest rates will rise to about 3%, which will curb inflation.” “In the interest rate decision for the actual development of inflation, ie a decision to stop interest rate increases will be based on clear signs of actual inflation converging to the target range. In the coming months we think it will be difficult to reach such a conclusion, so interest rates are expected to continue rising.”
Inability to transfer relief will roll into inflation
The Knesset disperses with a five-month surplus in state tax revenues. However, other necessary reductions in the cost of living may be perceived as an election economy, although in view of the rise in electricity and fuel prices, they are in demand.
When Finance Minister Avigdor Lieberman extended the reduction of the tax on fuel, and even increased the reduction to the shekel in the price of fuel at stations, it was a moment after Bennett announced the dissolution of the government and therefore the additional relief rolls to the speaker’s table. Israelis do not support moderating inflation, but wage agreements that will be rejected due to the dissolution of the government remove fears of a wage spiral that will fuel inflation.
Central banks around the world are raising interest rates
Global interest rate hikes are among the factors that support the continuation of the rather aggressive rate hike in the interest rate path taken by the Bank of Israel. Earlier this week, the central banks of Norway and Canada raised interest rates by half a percent, and in the US the Fed raised interest rates by 0.75% – the sharpest rise since 1994, although the round of interest rate hikes may moderate as signs of a recession intensify.
A global recession will not miss the Israeli economy as a result of the deteriorating conditions of its trading partners, such as in Europe. European Central Bank President Christine Lagarde said Wednesday that moving away from globalization would end the era of low inflation. So beyond the short term of the forthcoming interest rate announcement, it is likely that the Bank of Israel will continue to raise interest rates at each of the following meetings this year, the question is at what rate the increases will be chosen.
“The expected renewed growth in private consumption in the second quarter after the technical contraction in the first quarter, combined with the rise in annual inflation, and the sharp rise in interest rates in developed markets, support the continued raising of the Bank of Israel during each of the upcoming meetings,” said Modi Shafrir. . “It seems that the Bank of Israel will raise the interest rate by 50 basis points (0.5%, GBP) at the next meeting, especially in light of the sharp rise in US interest rates, the sharp rise in interest rates in other developed markets, and the fact that the local interest rate market and forecasters Similar at the next meeting.
“It seems that only the governor’s statements (and recent interest rate announcements) that the route of raising interest rates will be ‘gradual’ can prevent a 50-point increase in the next meeting. “It is still gradual, albeit in a higher range.”