Judging by the latest CPI figures and monetary data published in recent days, the new policies of the Bank of Israel have not yet influenced the Israeli economy. Despite a 25 base point rise in the interest rate at the end of August, the amount of money continues to grow swiftly, while annual inflation is far above the top mark of the government's target.
Under regular circumstances, and if there were not other considerations, one would expect another interest rate rise from the Bank of Israel to the tune of another 25 base points. Such a move is justified after prices have risen 3.7% in the past year, while the amount of money in the economy has grown by 60%. Moreover, the Israeli economy has begun to recover from the recession, and this is reflected in local demand.
In actual fact the Bank of Israel must cope with a situation that does not exist elsewhere. In overseas markets inflation is not rising, and that will only happen when recovery is far more advanced. But that is not the case here where inflation has gone up in the early stages of the recovery. All explanations about seasonal trends or the new drought tax don't help. There will always be such factors, and the real question is whether other factors are slowing down the rise in inflation. If the answer is no, as is happening in Israel, then there is an inflationary problem.
The Bank of Israel is forced to make decisions, which are not easy in light of this fact. In order to support a continued recovery low interest rates are needed, but it is proven that this is not necessary. But to maintain price stability and keep to government targets on inflation, interest rates must be hiked and not just by half a percentage point.
What remains for Stanley Fischer to do is to try and walk cautiously in the rain and hope that he doesn't get too wet. Translated into actions, the Governor of the Bank of Israel must consider postponing raising interest rates although that seems to be something which cannot be prevented. He can try putting off the next interest rate hike by a month, or even two months, and see if last month's rise has any influence on the markets, and whether inflation slows.
On this matter it should be stressed that the capital market over the last month has shown that it believes that this is what will happen. This is shown by the data for inflationary expectations on the bond market, which fell slightly compared with the end of August 2009. This strengthens the possible decision to hang on a little before putting up interest rates. But even so we are only talking about a postponement, not a cancellation. From that point of view that next interest rate rise was set in motion on Tuesday when the Central Bureau of Statistics announced the 0.5% rise in the CPI for August. Continuing inflation ensures the interest rate will rise sooner rather than later.
Published by Globes [online], Israel business news - www.globes-online.com - on September 16, 2009
© Copyright of Globes Publisher Itonut (1983) Ltd. 2009