In response to the sensational GDP figures published yesterday, showing that the Israeli economy grew at an annual rate of 7.8% in the fourth quarter of 2010, Citigroup Global Markets analysts David Lubin has produced an updated assessment of likely Bank of Israel monetary policy. Because growth is being fuelled by domestic consumption, Lubin estimates that the central bank will need to raise interest rates and allow the shekel to strengthen in order to keep inflation under control.
"It's been clear for some time that Israel has some of the characteristics of an ‘Asian tiger’, and the fourth quarter GDP data seem to support that idea. Israel boasts a number of features of better-known Asian success stories further to the east. It is highly open (exports are over 40% GDP); it enjoys a current account surplus and very low levels of foreign debt (in fact, it is a net foreign creditor); its success is based on an impressive technology sector; and it grows. Q4 GDP rose by a seasonally adjusted 7.8% annualised over the quarter, way above the market's 4.2% forecast," Lubin writes.
However, in one very important respect, Israel differs from the Asian tigers "But while the rate of Israel’s growth seems ‘Asian tiger’-like, the composition of that growth isn’t: Israelis like to spend," Lubin continues. "Private consumption was up 9.8% annualised during the quarter, with durables purchases up an astonishing 40%. Domestic spending on this scale pushed up import growth to 22.5%. All this is consistent with the one area where Israel’s economic fundamentals depart from their East Asian counterparts: savings. Asian tigers have a much stronger savings culture than Israel does. Israel's saving/GDP ratio is closer to 20% than the 30%+ that many Asian economies enjoy.
"The strength of domestic spending within the GDP data will give the Bank of Israel pause for thought: monetary policy needs tightening through rate hikes and stronger shekel. While it is possible that these GDP data could be revised down, the idea of a strong Israeli consumer makes intuitive sense: real interest rates are exceptionally low, a recession was avoided in 2009, confidence is high and the shekel is relatively strong in real terms. And strong domestic spending growth may help explain a 3.6% year-on-year nflation rate in January which, like the GDP data, came out higher than almost everyone’s expectations. With these two data points in mind, a 25bp rate hike on Monday (to 2.5%) looks likely indeed, and we think a further 100bp this year could be needed. Even this might not be enough.
"The basic question confronting the Bank of Israel is this: are the Bank’s interventions in the FX market helping to erode the credibility of its commitment to the inflation target? Since this question is in the air, and since growth seems very strong, we think the Bank may lean towards allowing more shekel appreciation over the next few months. A combination of decisive rate hikes and a stronger shekel could both be needed to keep inflationary expectations under control, in our view," Lubin concludes.
Published by Globes [online], Israel business news - www.globes-online.com - on February 17, 2011
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