The higher than expected rise in the June Consumer Price Index (CPI) of 0.9% sees inflation running at 3.6% over the past year and forces Bank of Israel Governor Stanley Fischer to re-examine all the basic policies that he has led in recent months.
Fischer has reached a crossroads.
Put simply, Fischer must ask himself if the time has come to raise interest rates. It is no secret that heads of other countries central banks have begun talking about "exit strategies" from policies of monetary expansion. In other words, the heads of the banks must find ways to reduce the growth in payment means and liquidity in the economy.
In Fischer's case, an exit strategy includes handling the Bank of Israel's purchases of foreign currency. Fischer knows that he must make a decision on these two issues. The exceptional rise in the CPI in June compels him to make these decisions sooner.
The bottom line is that Fischer has two alternatives. The first is to decide not to decide, and carry on with his current policy, until it becomes clear that rising inflation is a real threat and not a passing phenomenon. The reason for such a decision will mainly be the state of the real economy. The recession is still here and many companies are suffering from low demand.
On top of that, the strengthening of the shekel, which will result in an end to the dollar purchases by the Bank of Israel and expanding payment means, will intensify the damage to exports and employment. Fischer can decide that the reasons for the rise in inflation in June - mainly the rises in the price of energy and seasonal clothing - are temporary, and do not require a deviation from the course he has set.
On the other hand, Fischer can decide, and it is reasonable that he will decide, that the time has come for a change. Firstly, the amount of money in the economy has expanded by almost 60% over the past year, which has added fuel to the inflationary fire. Secondly, no small part of the damage to the real economy in Israel stems from the sharp fall in global trade, and under these circumstances, interest rates in Israel have no influence whatsoever.
In these conditions, the Bank of Israel will choose to gradually change its policy, firstly by reducing the rate of growth in the amount of money, and subsequently, if there will be the need, with a more openly restrictive policy, on the assumption that the economy can withstand this.
Of the two options, this seems the more reasonable. In effect, in recent months the rate of monetary expansion has been far slower than between January and April. And we can assume that it will continue to contract in the coming months. The Bank of Israel will also monitor the NIS exchange rate to ensure that there is no exaggerated strengthening of the Israeli currency.
However, anybody who expects an official announcement of the policy change will be disappointed. Officially, the Bank of Israel will continue to be committed to the same policy. But over time it will be difficult to conceal Fischer's change in emphasis. When the minutes of the Bank of Israel's monetary discussions for July are published next month, they will reveal the extent of the concerns over inflation, and how difficult Fischer's dilemma is.
Any decision taken is fraught with risks, which are not simple, and any measure adopted by Fischer can make Israel's economic problems even more severe.
Published by Globes [online], Israel business news - www.globes-online.com - on July 16, 2009
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