To a large extent, this week will set the direction of the Israeli economy for the coming months. At the focus of attention will be the unusually high tension on the various security fronts, the Consumer Price Index reading for March, and the credit rating for Israel from the most important of the rating agencies, Moody’s. By the end of the week, we shall know whether inflation is receding, which will give some indication of future developments in the Bank of Israel’s interest rate, and we shall also have a better idea of how far the changes in Israel’s legal system that the government is advancing will really influence the rating agencies.
The uncertain security situation has so far mainly affected the foreign exchange market and shekel exchange rates. During the Passover holiday, the impact of the escalation on Israel’s borders and of terrorist attacks within the country has been felt rapidly and sharply. The shekel has lost 1-2% of its value against the US dollar and the euro, with the shekel-euro rate at a two-year high and approaching NIS 4/€.
The depreciation against the US dollar is a reversal of the trend that prevailed before the escalation, when the shekel strengthened, aided by the dollar’s global weakness. The US Dollar Index (DXY) is currently at around 102 points. As the shekel weakened last weak, the index reached a two-month low of 101.6 points.
Things are quieter on the Tel Aviv Stock Exchange, which opened the shortened trading week (because of the Passover holiday) mixed and not exceptionally volatile. As is to be expected during the intermediate days of the holiday, trading has been very thin. Turnover in equities yesterday was NIS 415 million, which compares with an average daily turnover of NIS 2.1 billion in the first quarter of 2023. Turnover in bonds was NIS 534 million, which compares with an average daily turnover in the first quarter of NIS 4.1 billion.
The security situation: This time it could be different
Mizrahi Tefahot Bank chief markets economist Ronen Menachem warns in his market review that the security situation could affect the markets. "In general, past experience teaches us that, over time, the security question has diminished in importance for the capital market," Menachem writes, but adds that the current round could have a greater impact because of the many fronts, the coincidence of the sensitive periods of Passover and Ramadan, and the continued protests against the judicial overhaul. Because of these combined factors, Menachem says, the danger of a conflagration is also greater. "This is already reflected in the shekel, which has depreciated by 1.4% in comparison with last Tuesday’s representative shekel-dollar exchange rate. The longer the escalation continues, the more significant the impact on GDP and economic activity is liable to be."
Inflation and interest rates
Even if the security tension eases, two macro events due to take place on the same day will be highly significant for the Israeli economy. The first and more routine one is the release of the Consumer Price Index figure for March this Friday. While, around the world, signs are emerging that inflation is coming under control, Israel is a long way from that. The latest forecast from the Bank of Israel Research Department is for annual inflation to be running at 3.9% at the end of this year, which is above the 1-3% target range. The February Consumer Price Index reading was surprisingly high, showing a monthly surge of 0.5% and an annual inflation rate of 5.2%.
"The Bank of Israel published an interest rate forecast under two scenarios. One was that the dispute over the changes to the legal system is resolved, in which case the Bank of Israel’s interest rate is forecast to be 4.75% in the first quarter of 2024, and Governor of the Bank of Israel Amir Yaron said that if inflation moderates, the interest rate could even fall," says Modi Shafrir, chief financial markets strategist at Bank Hapoalim.
Under the second scenario, Shafrir continues, "The legal and institutional changes are accompanied by a rise in the country’s risk premium, in which case the central bank estimates that its interest rate will rise next year as well, and will be 2% above the level in the ‘dispute resolved’ scenario," meaning that it could reach a peak of 7%.
A critical report for Israel’s credit rating
The other event due to take place on Friday is the release of a forecast for the State of Israel’s sovereign rating by international rating agency Moody’s. The rating is currently a very healthy A1, but expectations of the coming review became murkier when the agency published an "Issuer Comment" on March 7 bearing the headline "Planned judicial changes could weaken Israel's institutional strength".
In its comment, Moody’s warned that if the proposed judicial overhaul was implemented in full, it would substantially weaken Israel’s legal system and would therefore have negative implications for Israel’s credit rating - for the time being for the rating outlook (which was upgraded to "Positive" a year ago) rather than for the rating itself.
Now that the legislative process has been temporarily frozen while talks between the government and the opposition take place under the auspices of President Herzog, it could be that we shall hear more moderate noises from the rating agencies, but at this stage it is hard to make a guess.
Published by Globes, Israel business news - en.globes.co.il - on April 10, 2023.
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