The fight against inflation will be more difficult than the central banks estimated, and this will require high interest rates over time. The economy is now facing the renewal of agreements in the public sector. Agreements that include a high salary adjustment may create complexity, both due to their contribution to the increase in the budget deficit, but mainly due to being a point of reference for the business sector, at a time when the labor market is characterized by a high demand for employees.
The Bank of Israel raised the risk level of the State of Israel The data and the meanings
The Accountant General published the annual report for the execution of the budget for 2022
Governor of the Bank of Israel: “The steps to mitigate price increases are reasonable”, and what will happen to the interest rate?
A high increase in wages could feed another wave of price increases and a continuous inflationary process (wage-price spiral). In such a scenario, inflation will remain close to the upper limit or above it well beyond the year 2023. The movement of the scissors of falling apartment prices and an increase in NIS lead to a gradual increase in the rental yield, this as a response to the increase in interest rates worldwide.
The real interest rate will have to continue to rise to reduce inflation, and in light of an increase in inflation expectations, this means that we will see an interest rate higher than 4% throughout the year.
Israel
In the past week, two economic figures were published, which were significantly above the consensus forecasts, and the conclusion that emerges from them is that the fight against inflation will be more difficult than the central banks estimated, and this will require high interest rates over time.
The price index for the month of January increased by 0.3%, with the seasonality of the month of January being negative. The annual inflation level in Israel rose to a rate of 5.4%. Another surprise came from the direction of growth – this stood in the fourth quarter of 2022 at an annual rate of 5.8%, a figure that is high in relation to the monthly economic indicators published in recent months, as well as in relation to the growth potential of the economy. High growth is indeed a positive figure for the economy, but it is expected to make it difficult to reduce inflation.
Growth in 2022 amounted to 6.5%, after even higher growth in 2021 at a rate of 8.6%. The GDP level has returned to the pre-corona growth path, and even beyond that. If the goal of the monetary policy is to cool the economy, then so far the success is partial. It works well in the real estate market, but to a lesser extent so far in the recession of private consumption, as well as on the labor market which is still tight.
Inflation is partly imported from the world and partly focuses on the prices of services. The prices of services are affected over time mainly by wages and processes of technological improvements that increase productivity. The economy is now facing the renewal of wage agreements in the public sector.
Agreements that include a high salary adjustment may create complexity, both due to their contribution to the increase in the budget deficit, but mainly due to being a point of reference for the business sector, at a time when the labor market is characterized by a high demand for employees. A high increase in wages could feed another wave of price increases and a continuous inflationary process (wage-price spiral). In such a scenario, inflation will remain near or above the upper limit well beyond 2023.
The service industries led the growth in 2022. The high growth figures are misleading to a certain extent as they largely reflect the comparison to 2021 in which the service sector still suffered from the Corona restrictions. In fact, if you look at the growth in the fourth quarter of 2022 compared to the corresponding quarter last year, the growth stood at a rate of 2.7%.
For example, the product of the hospitality and food services industry rose by a sharp rate of 19.5%, and that of transportation, storage and mail services by 15.8%. The return of workers to the service industries was also manifested in a 7.2% increase in working hours in the economy as a whole, so that despite the high growth, labor productivity in general decreased.
We expect inflation at a rate of 3.0% in the coming year. The housing and food items will be the biggest contributors to inflation in the coming months. The CBS reports that in rental contracts in which the tenant changed, the price increased by 7.9%, this increase implies further price increases in the housing section of the Consumer Price Index in the coming months. We estimate that the risk factors have multiplied, such as an increase in the budget deficit and wage agreements in the public sector against the backdrop of a market Work closely, which may leave inflation at a level of 3% and maybe even more in the next two years.
The real estate market is cooling down. The national apartment price survey still indicated a slight price increase of 0.2% in the November-December survey, however, if you look at the prices of new apartments, they recorded a monthly decrease of 0.6% and in the last three months by 1.4%. Excluding apartments within Price project for the tenant, the decrease is greater, and it must be remembered that the measurement does not include benefits such as an exemption from linking to an example index, or a mortgage interest subsidy for a limited period.
Construction site (Photo: Gili Yaari, Flash 90)
We are now seeing a decrease in apartment prices in almost all developed countries in the world, at the same time as an increase in rental prices. In the United States, rent prices have increased by 7.9% in the past year and in Israel by 6.7%. The movement of the scissors of falling apartment prices and an increase in the Shed result in a gradual increase in the rental yield, this as a response to the increase in interest rates worldwide.
The real interest rate will have to continue to rise to reduce inflation, and in light of an increase in inflation expectations, this means that we will see an interest rate higher than 4% throughout the year. In response to the published data, and perhaps also due to the effect of the devaluation of the shekel’s exchange rate in recent weeks, there was an increase in inflation expectations. Expectations for one year now stand at about 3% and for two years at 2.7%.
With reference to inflation expectations, the Bank of Israel’s interest rate in real terms is lower than 1 percent, and in our estimation this means that in the next decision or the one after that, the interest rate will already rise to 4.25%. The markets now embody an interest rate of about 4.5% at the end of the year.
global
The January inflation data in the US brought back investors’ concerns about stubborn inflation and the central bank’s response to such a scenario. Against the background of the high figure and good economic activity data, especially those of the labor market, expectations for an increase in interest rates from the capital market rose and the ten-year yield rose to 3.82 %.
The stock markets in the world recorded a mixed trend. In the US, the Dow Jones and the S&P500 fell by up to 0.3% while the Nasdaq rose by 0.6%. The performance of European stock indices was better, with a weekly increase of 1.8% in the Eurostox 50 index, among other things influenced by increases of 3.1% and 2.4% in the indices in France and Spain respectively. In Asia, most of the stock indices recorded price decreases, and the declines in Hong Kong and China stood out at rates of 2.2% and 1.8%. The price of a barrel of Brent oil fell last week by about 4.0%, to the level of 78 dollars, and the index of all commodity prices fell 2%.
U.S
The annual inflation rate was surprisingly upward. The consumer price index rose by 0.50% in January, similar to expectations, mainly due to the increase in the rent index, which rose by 0.7% last month and by 7.9% in the last 12 months. In the last 12 months, the index rose by 6.4%, a higher rate than expected due to a 0.2% upward revision of the December data.
The core index increased by 0.4% and in the 12 months it increased by 5.6%. The producer price index rose in January by 0.7%, well above the forecast of 0.4%. This is the highest monthly increase in the last seven months. The core component increased by 0.5%, the highest rate since May last year. The annual rate of inflation is indeed moderating, but at a slow rate and the inflation environment is still far from the Fed’s target (2% per year).
An increase in yields to maturity and a change in estimates regarding the Fed interest rate. The capital market is now anticipating between two and three interest rate increases of 0.25% at the Fed meetings in March and May, so that the interest rate will peak in July at a level between 5.25%-5.5%, and that the interest rate at the end of 2023 will drop slightly but remain at a high level of 5.25%, similar to the Fed members’ estimates from December 2022. The interest rate for longer terms also increased, and the capital market estimates that the interest rate at the end of 2024 will be around 4.0% and at the end of 2025 at a level of around 3.5%. As mentioned, the ten-year yield increased from 3.74% to 3.82% and the two-year yield increased from 4.52% to 4.62%. Current yields are the highest in the last three months.
Activity in the real estate market continues to moderate, while prices continue to fall. The decline in activity in the housing market continued against the background of the sharp increase in mortgage interest rates and high housing prices. Construction starts and the number of building permits continued to decrease in January 2023. Construction starts decreased by 4.5% and completed a decrease of approx. – 27% from the peak in April, and construction permits remain unchanged but their level is about 30% lower than the peak in December 2021. Apartment prices as measured by the Case Shiller index for the twenty largest cities in the US have decreased cumulatively from June 2022 to November 2022 by about 5.4%, And according to market estimates, they are expected to increase and decrease.
Nasdaq (Photo: Reuters)
The Eurozone
Yields to maturity on government bonds have risen significantly recently. The growth figures in the Eurozone for the fourth quarter indicated a growth of 0.4% (annual terms) so that the growth in the summary of 2022 reached 3.5%. Despite the impressive growth in the past year, the European Commission predicts that the growth in 2023 will slow to a level of only 0.9%, partly due to a forecast for growth of only 0.2% in Germany. The labor market remains strong, and the number of jobs increased by 0.4% in the last quarter of 2022 to the highest level since the beginning of 2021 and above the forecast.
On the other hand, the industrial production data in the Eurozone indicated a higher than forecast drop of 1.1% in December, this due to the weakness in the energy sectors. In recent weeks, similar to the USA, there has been an increase in yields in the Eurozone economies. The ten-year yield in Germany rose to 2.53% per year and in Italy the yield rose to 4.30%. The rise in yields reflects an expectation of continued interest rate increases by the ECB, and the interest rate is now expected , according to the embodied in the capital market, to rise to a level of 3.50%-3.75% at the end of 2023.
Japan
Growth is lower than expected in the fourth quarter of 2022. In the fourth quarter, growth of only 0.6% was recorded (quarter over quarter in annual terms) and the third quarter figures were updated downwards and indicated a contraction of 1.0% in GDP. In the summary of the year 2022, a low growth of only 1.0% was recorded in Japan. The Japanese government last week appointed Kazuo Ueda as the new governor of the central bank, as well as two new deputy governors. The new bank governor will have to decide soon whether he continues the expansionary policy that the central bank has been following in recent years.
Japan’s economy (Photo: Reuters)
China
A third week of declines in the stock indices mainly against the background of the increase in geopolitical risks. Tensions between the US government and China have reached new heights following US claims of the existence of Chinese spy balloons in the US. In the real estate market, housing prices remained stable in January after 16 months of consecutive declines. Among the factors that influenced the containment of the monthly declines are the government programs to support the industry and the flexibility in government policy regarding closures following the corona virus. It is likely that additional government support measures, alongside an expanding policy by The Central Bank, will be activated in the coming months.