"Due to recent inflationary developments, the process of monetary tightening might be faster than we thought," Bank of Israel deputy governor Andrew Abir said today at an online conference organized by Tel Aviv University's Koller Faculty of Management Alrov Institute for Real Estate Research.
In early February Abir had told "Globes" that even if inflation exceeded the upper limit of the Bank of Israel's target range (1%-3%), the decision makers at the Bank of Israel would be in no hurry to change their policy. However, the picture has since changed dramatically following the Russian invasion of Ukraine, which is adding to inflationary pressures.
Following February's Consumer Price Index (CPI) reading, annual inflation in Israel has risen to 3.5%. Also since then the US Federal Reserve has raised interest rates for the first time since 2018, and the market believes that the Bank of Israel Monetary Committee will raise the interest rate above its historic low of 0.1% at its next meeting on April 11.
Abir said today, "With the recovery from the crisis, central banks around the world began to reduce the degree of monetary expansion that they had led. The Bank of Israel began reducing monetary expansion already during 2021, with a gradual halt of the special expansionary programs that it operated during the crisis. The crisis in Ukraine has added complexity in setting monetary policy as it creates a shock on the supply side. It might delay the return of inflation to the target beyond what we estimated prior to the outbreak of the crisis.
"The Israeli economy was more impressively successful in getting through the crisis compared with other countries. This was due to the good economic conditions of the Israeli economy before the crisis and due to Israeli high-tech, which grew quickly. The renewed demand for services and goods as part of the world's exit from the crisis hit a supply bottleneck. This led, among other things, to a rise in inflation worldwide and in Israel, although inflation in Israel was and is significantly lower than in most OECD countries. With the publication of the most recent CPIs, the inflationary expectations for the next year from most sources is at the upper end of the target and medium and long-term expectations are within the target."
Abir revealed the trap that central banks are caught in when it comes to tackling inflation. "While the stability of prices is a main target of the central bank, central banks are also aware of real economic activity. When the economy is hit by the shock of negative demand, both prices and activity require an expansionary monetary policy. But when the economy is hit by negative supply like that which the global economy is facing due to the crisis in Ukraine, the central bank is in a dilemma. To what extent should it tighten monetary policy in order to cope with the shock, which could not only lead to higher inflation but also slow domestic demand. Moreover, it also introduces uncertainty, as it is never really possible to know how long the supply shock will last, and what its impact will be on both prices and activity. These are considerations that will affect the pace and duration of interest rate normalization process. These are clearly challenging times for monetary policy makers around the world."
Published by Globes, Israel business news - en.globes.co.il - on March 24, 2022.
© Copyright of Globes Publisher Itonut (1983) Ltd., 2022.