The July inflation figure published at the end of last week, together with the money supply growth data released by the Bank of Israel and the second quarter growth figure, form the best backdrop the Bank of Israel could wish for for the next twist in monetary policy. The bottom line is that everything is set for a 25 basis point interest rate hike.
The possibility must be taken into account that Governor of the Bank of Israel Stanley Fischer will want to wait for an easy opportunity, after interest rate rises elsewhere. It could be though that Fischer will show the way to the other central bankers and will be the first to return to a trend of rising rates, given the growth in money supply and accelerating inflation. The fact that the Israeli economy is growing again (by an annualized 1% in the second quarter) can only bolster Fischer’s confidence that the time has come to change direction on monetary policy.
The inflation figures are perfectly clear. The CPI rose 1.1% in July, and the inflation rate, according to the Central Bureau of Statistics, is 5%, almost double what the Bank of Israel considers acceptable. It’s true that some of the rise in July is attributable to government action, but that does not alter the fact that the prices of many products and services rose as a result of the forces of supply and demand.
On the capital market, twelve-month inflation expectations continue to creep upwards. According to Bank of Israel data, they reached 2.7% over the past 30 days, compared with 2.4% on average in June and July. In April, expectations of inflation twelve months forward were 0.8%. This trend, more than any public statement from an analyst, expresses what the capital market thinks about inflation in the Israeli economy.
In previous months, the Bank of Israel could still argue that it had to consider an interest rate rise carefully, because of the effect on shekel exchange rates, which have become an additional variable in the Bank of Israel’s decisions, almost officially. But in the past month, a very important shift in monetary policy has taken place. The central bank stopped buying government bonds, and announced the end of its program of buying $100 million worth of foreign currency daily. The thing that is meant to stop the shekel strengthening substantially in the event of an interest rate rise is the threat of massive intervention by the central bank, at least according to the bank’s calculations. Now it’s the turn of the interest rate, which is due to rise, in the next stage of the Bank of Israel’s change of course on monetary policy.
On the side of the real economy, as mentioned, conditions now seem riper for an interest rate hike. GDP figures in Israel and around the world are starting to indicate a return to growth, albeit very slow. Growth in Israel is positive, and in Europe too the figures indicate a similar direction, while the US Federal Reserve is also starting to talk about the US economy growing again. The Bank of Israel now has a greater degree of freedom, and so the chances of an interest rate rise have grown, if not this month, then next.
In fact, it’s doubtful whether the Bank of Israel can afford not to act on interest rates. Its alternative is to let the money supply continue expanding at a rate of over 50% a year, and to take the risk of an additional spurt in inflation, which will force it to take much tougher action later on. This is not something that can be contemplated, and therefore Fischer will have to announce an interest rate rise, perhaps wrapped in calming language, and accompanied by a statement that the Bank of Israel will continue to monitor developments in the real economy closely and will avoid any harm to it. This is a matter of a ritual form of words, no more than that. From now on, the Bank of Israel will go back to thinking first and foremost about inflation.
Published by Globes [online], Israel business news - www.globes.co.il - on August 16, 2009
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