Israel's capital market and business sector will have to soon decide what is the significance of the 0.7% drop in the CPI in January 2010. Will inflation in 2010 be less than expected, or was last month's drop in the CPI due to one-time factors that won't affect the inflationary path on which Israel is embarked?
To answer this question we must refer to what is known about the inflationary process of recent months. First, the Israeli economy is entering an inflationary environment that is within the government's 1-3% target range. It seems that all the figures of the January CPI reflect the success of the Bank of Israel's monetary policies to rein inflation back within the target range. The increase in the money supply has slowed, and the year has begun with low inflation rates.
However, anyone who is anxious about a drop in prices and deflation should relax. It won't happen this year. Domestic demand is rising, not falling; households are expanding consumption, not reducing it.
The entire debate revolves around a much narrower issue: will we return to within the price stability target range only later this year, or have the Bank of Israel's plans already achieved their goal?
It must be admitted that there were statistical factors in play in January, such as the Central Bureau of Statistics' method for measuring the higher arnona (local property tax) bills, which pulled the CPI down. If the seasonal drop in clothing and footwear and fruits and vegetables prices are also taken into account, the result is a drop in the CPI. From this perspective, little appears to have changed from late 2009.
However, it is equally possible to conclude that the slowing of inflation has accelerated. In practical terms, the January inflation figures will halt, perhaps temporarily, the Bank of Israel's interest rate hikes. If the economy already has 2% annual inflation, then the Bank of Israel will keep the interest rate unchanged in the medium term.
It can be assumed that the Bank of Israel will prefer to wait before making a celebratory proclamation of Victory over Inflation. Governor of the Bank of Israel Prof. Stanley Fischer will keep the interest rate unchanged for now, and review the CPI figures in a few months.
The January CPI also has repercussions on the capital market. The Bank of Israel today reported that the capital market predicted - even before the CPI announcement - 2.2% inflation in 2010 and the 12-month inflation forecast is 2.8%. Everyone is now headed back to the conference rooms to recalculate their figures, and to try to predict whether inflation will again rear its head in the coming months, which will force the Bank of Israel to take preventative action.
Published by Globes [online], Israel business news - www.globes-online.com - on February 16, 2010
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