| Alex Zabrzynski, Chief Economist of Meitav Dash
| Israel: Surveys indicate increased inflation risk
The CBS Business Trend Survey showed a relatively rapid expansion in activity in January in most industries despite the wave of morbidity. With the exception of the hotel industry, all industries improved compared to December.
According to the survey, the problem of shortage of raw materials and equipment continues to be acute, especially in the manufacturing and construction industry. The recent congestion in ports may further exacerbate gaps and delays. The survey also reports an exacerbation of the shortage of workers, especially in the trade and services industries, possibly mainly as a result of the high morbidity
About 30% of businesses in the retail trade and close to 20% in the services sector (especially in the food services industry) reported that they expect prices to rise beyond the normal seasonality. These are the highest figures since the start of the 2015 survey.
The rate of businesses expecting more than 3% is at its peak. Business expectations for price change are a very important indicator that they actually set prices.
| Does lowering caps affect prices?
The economic program to help households is expected to strengthen private consumption, which even before the program was expected to grow by about 8% this year.
The analysis carried out by the Ministry of Finance in 2019 shows that the effect of lowering tariffs on prices is not uniform. Tariff reductions in 2012-2013 did not affect prices.
In contrast, lowering quotas and increasing import quotas on products that have significant domestic production, such as fresh meat and tuna, have apparently managed to lower prices.
It is likely that this time too the reduction of tariffs on industrial products produced mainly abroad will be rolled into the pockets of businesses. ‘.
We will also note in connection with the effects on prices, that in the event of a war in Ukraine, the prices of oil and some of the other goods will rise. Have already risen sharply on Friday.
It should also be noted that it continued to weaken faster than other currencies in the world, especially in response to the exacerbation of geopolitical risk.
Bottom line: We estimate that the overall effect (including reducing the increase in the electricity tariff) on the price index of all the measures announced by the government is expected to amount to lowering the annual forecast by 0.1%. We will update the forecast after the publication of the price index for January.
| There is an option to lower VAT
In January, which amounted to about NIS 47 billion, it constitutes about 14% of the forecast for the total collection in 2022, compared with a weight of about 8.5% of the annual revenues in January in recent years.
Tax revenues in the last 12 months are about 12% or NIS 43 billion higher than the long-term trend.
As a result of the NIS 18.5 billion surplus in the government budget in January, the cash balance in the Treasury once again rose sharply above NIS 80 billion, about NIS 40-50 billion more than was the norm before the corona crisis.
These surpluses can be used to reduce debt (reduce issues / repurchase bonds) or for expansionary fiscal measures such as reducing taxes or increasing government spending depending on the budget and the ability to change tax brackets.
It is doubtful that the Ministry of Finance will further reduce the size of the issues, which are already quite low, or repurchase bonds.
It should also be borne in mind that designated bond issues will cease as early as the second half of the year.
It is very likely that the government will use surplus tax collection to take additional economic measures to increase household income and / or lower the cost of living.
One of the easiest steps to implement that lowers prices can be to lower VAT. Even if a large portion of businesses do not pass it on to the consumer, it allows companies to avoid or delay price increases resulting from increased costs.
The Deputy Governor of the Bank of Israel emphasized last week that the Bank will be patient with even if inflation temporarily exceeds the target. The interview he gave was probably intended to curb the momentum of rising yields on government bonds and to support the weakening of the shekel.
In the current reality, such messages from central banks should be treated with caution. If the inflation environment is rising, which in our estimation is indeed happening, the Bank of Israel will have to make a U-turn, as the other central banks in the world have done before it,
The markets’ response to the Bank of Israel’s message was a bit confused. On the one hand, inflation expectations rose and the shekel weakened, as expected from lowering expectations of rising interest rates.
On the other hand, bond yields rose by 0.1%, while long-term bond yields fell by 0.1% – a classic response to expectations of rising interest rates.
We estimate that in the end the Bank of Israel will have to raise interest rates in response to rising inflation. A one-time reduction in prices or a delay in price increases as a result of government actions will not change the trend based on the structural forces of the tight labor market, an increase in import prices and an increase in expectations of price increases.
As long as the Bank of Israel does not curb monetary policy, the risk of high and prolonged inflation is expected to remain high.
| World: There is a risk that inflation in the US will change from temporary to structural
Risk in the US continues to worsen with an increase in the rate to 7.5% and the core to 6%. Another sign of this is that the rate of small businesses raising prices has reached a peak of 61%, the highest level since 1974.
The rate of inflation continues to rise, although in the purchasing managers’ indices and other indicators there is a relief in supply chain problems.
The annual rate of increase of the price index (excluding energy services), which should not be related to supply chain problems, rose to 4.1%, the highest since the early 1990s.
In light of these data, there is concern that US inflation will become structural and will not fall significantly even if supply chain problems are resolved.
| The market (and the Fed) is still “behind the curve”
If the forces driving inflation become structural, more restraining monetary policy is needed. The interest rate contracts already represent an increase of up to 1.6% this year and even a high chance of an interest rate increase of 0.5% in March.
However, the increase in the interest rate forecast for 2022 occurred in parallel with the decrease in the forecast for an interest rate increase in 2023 from 0.7% at the beginning of January to about 0.5% today. In 2024 the market expects only one interest rate increase of about 0.25% and for 2025 the estimates embodied in contracts in general have dropped from about 0.1% to a decrease of about 0.5%. In the end, the peak interest rate is expected to reach only 2.3%.
Even among economists, forecasts of interest rates at the peak of turnover are not far from market estimates. Only one economist out of the 54 quoted in Bloomberg expects the interest rate to reach 3% by the end of 2023. The majority believe it will stand at 2.25%.
Since the 1950s there has been no case in which core inflation in the US has returned from rising above 3% without the Fed interest rate not rising above inflation.
There are two options here: one is that the Fed will have to raise interest rates well above market estimates to levels of 3% -4%. In this scenario, bond yields will further rise significantly.
In our view, the US economy can withstand this rise in interest rates provided that the economy continues to grow in line with existing growth forecasts while declining the rate of inflation.
The second possibility is that US inflation will be halted following a significant slowdown in growth as a result of erosion in consumers’ real incomes if the Fed does not act quickly and forcefully to curb inflation.
| The risk of hitting growth has risen as a result of rising US inflation
Of the two options we mentioned, the risk of realizing the second option appears to be worse, due to the establishment of the inflation environment. Also, more worrying signs are starting to appear in the economic data and surveys.
Despite declining morbidity, U.S. small business sentiment fell to its lowest level in January since March last year. A University of Michigan survey in February dropped to its lowest level since 2011.
According to the results of the surveys, everyone is worried about problems directly or indirectly related to inflation. Businesses are primarily concerned with rising costs associated with hiring workers and their shortages and rising prices that could erode profits.
Consumers are particularly troubled by price increases that are hurting their purchasing power. The real average has fallen by at least the largest rate since 2007.
Rising prices have continued to hurt the terms of purchase of cars and homes to the worst level since the survey began in the 1970s
| Fears of the ECB retreating pose a risk to southern countries’ bonds
Both recent developments pose a risk to the European economy. First, an increase in the geopolitical risk associated with the risk of war between Russia and Ukraine.
Second, a possible increase in Europe and especially the cessation of bond purchases by the ECB may be challenging for the ECB in view of the apparent increase in bond spreads of southern European countries relative to German bonds.
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The writer is the chief economist of Meitav Dash Investment House. This analysis is intended for the purpose of providing information only, and in no way should it be considered an opinion, offer, recommendation or advice / marketing for the purchase and / or holding and / or sale of securities and / or the financial assets described therein. The information contained in this review does not purport to contain all the information necessary for a potential investor and does not purport to constitute a complete analysis of all the facts and details appearing therein. This review is not a substitute for investment advice / marketing that takes into account the data and special needs of each person. Meitav Dash Brokerage, and its sister companies and other companies in the Meitav Dash Investments Ltd. group and / or stakeholders for any of the companies listed above and their clients, may have an interest in the securities and / or financial assets included in this review.