The Bank of Israel Monetary Committee, headed by Governor Prof. Amir Yaron, has raised the interest rate by 0.75% to 2.75%. This is the fifth successive rate hike made by the Bank of Israel since April, when it raised the rate from its historical low of 0.1% to 0.35%. Yaron sees another year of higher interest rates than we are used to ahead and insists that the rate hikes are required in order to restrain rising inflation, which is already being felt.
Yaron told "Globes," "As the Monetary Committee sees it, the Israeli economy has high growth, a very tight labor market and a record employment rate. Inflation is effecting a wide range of items, and over time more and more of these items are being identified with high demand. That is why we are continuing the process of raising the interest rate."
"Our estimates are that inflation will be between 4.5% and 5% until the end of the year and then a slow process of decline will begin. If everything goes according to plan, and all plans are subject to uncertainty, we predict that inflation will enter the target range by the middle of next summer and may be more in retreat towards the end of the summer. I estimate that the interest rate is currently in a range that will begin to curb inflation, so it should reach 3% plus in the future and then inflation will start moving towards the center of the target range."
The Bank of Israel's annual target range for inflation is between 1% and 3%, while inflation in Israel over the past 12 months is 4.6%. In its forecast today the Bank of Israel Research Department predicted 4.6% inflation in 2022, falling to 2.5% in 2023. The Bank of Israel sees 2.7% inflation in the four quarters up to September 2023.
When do you think you will be able to start cutting the interest rate?
"We see interest rates at 3% plus until the fall of 2023, or what the Bank of Israel Research Department defined as the middle of the third quarter. You have to understand, we are in a period of great uncertainty. We see that Europe is trying to deal with the energy crisis, and it is clear to us there will be a slowdown and some damage to activity in 2023. In the US it is not yet clear whether there will be a soft or harder landing. All of these things affect the time frame of the interest rate, not to mention geopolitical events that we witness and are factored into the forecast. An improvement in events could take us to a situation where inflation will indeed moderate more quickly. But if we see effects in the opposite direction, such as very expansive wage agreements, this may drag out the inflation process further. These things will dictate how long we will be in an interest rate environment of 3% plus.
"It is clear to us that this hurts quite a few businesses and households, and for sure through the rise in mortgage prices. On the one hand, we benefit from a fast growing economy, and we see the items that affect inflation passed to demand. The acceleration and promotion of interest rate hikes that we have carried out should prevent the need for even higher interest rate hikes than our Research Department predicts for the interest rate environment were we to carry out the current hikes more gradually."
In the US, it seems that the rate hikes have not hurt the public sufficiently in order to slow down consumption. Here to credit card expenditure is breaking records. How do you explain the gap between complaints about the cost of living and rise in mortgage payments and continued consumption?
"This is also has a positive side - the Israeli economy has high consumption and high activity. We see this in the job market, when for every unemployed person there is at least one vacant job. That is why, among other things, we have pushed forward with the (rate hike) process, because we saw that the economy has the ability to absorb it. The process of restraining interest rates takes time. At the point where we are now we are seeing it, but in theory it takes several months and even up to six months until you see the effect of the process. That's why we're talking about the second quarter of 2023, where we'll see the process being expressed more clearly."
What do you say to those who argue that you began raising interest rates too slowly?
"When I talk about monetary contraction and monetary policy, I include interest rate decisions, foreign exchange and all the very quick actions we took to deal with Covid. There has been a major challenge here with an epidemic and getting out of it. In June 2021 we ended all the special programs and relaxations, things that other central banks did not do until deep into 2022.
"You have to remember that our inflation has been lower and it is still lower, and that's a good thing. We don't want to reach the type of inflation they have elsewhere. There is no doubt that the crisis between Ukraine and Russia has added oil to the inflationary fire and prolonged all the processes. That's why inflation here has also been rising and that's why we also sped up the rate hike process. When you look at our interest rate increases in relation to the level of inflation and in relation to the deviation from the inflation target, you see that the Bank of Israel was actually among the first to act."
Since indicators for the third quarter of 2022 continue to forecast a high level of activity, the Bank of Israel has revised the 2022 growth forecast upwards and the Bank of Israel Research Department predicts that 6% GDP growth. The Research Department expects GDP growth to moderate to 3% in 2023.
The Research Department said, "The expected slowdown in growth is due to expected moderations in the growth of world trade, and in GDP growth in advanced economies, as well as an increase in the real interest rate in Israel within the forecast period. The current forecast reflects a higher level of activity in 2022-23 than the previous forecast, as shown by the upward revision of the forecasted deviation of GDP from the trend."
Does the slowdown that Israel is experiencing bring a risk of recession?
"We estimate that in the coming quarters, and certainly in the last quarter and perhaps in the first and second quarter of 2023, we will see a slowdown that, among other things, is partly effected by the interest rate increase process. But a large part of the effects that we take into account stems from the forecasts of the international organizations for Europe and the US, as well as for international trade affected by China.
"This is of course undoubtedly a decrease and moderation in growth, but it must be remembered that this is still in an environment close to potential growth, and a high figure compared with what we are seeing in Europe and the OECD is talking about 0.3% or 0.6% growth in the US. So yes, there is nothing to be done because this is part of the moderation that is required in part by reality so that inflation will fall, and in part also due to an exogenous process that depends on both the crisis in Europe and the monetary tightening that is taking place abroad."
Do you see the US entering recession?
"We are currently taking into account that there will be a slowdown, but we are still talking about some growth according to international organizations. By the way, in the latest data, for example according to the US Fed in Atlanta, we see data in the third quarter that are still good. But we estimate that in order to curb inflation and especially at the levels that it is there, and what with monetary tightening and the financial markets and what is happening in Europe, there will be a significant slowdown."
How do you reduce the influence of the American market on Israel?
"The US and Europe are of course important markets for the Israeli economy and this is part of what is included in the Research Department's forecast that talks about 6% growth in 2022 and 3% in 2023. But it is important to stress that Israel's economy is still a strong economy that has shown its ability to grow, at least in the short term, and through everything that we have seen in recent years."
Ministry of Finance director general Ram Belinkov was interviewed by "Globes" two weeks ago and he took issue with Yaron's remarks that it is not his job to take care of housing prices. He said that it is incorrect "to say that there is no connection at all between interest rates and prices in the economy in general. After all, the main role of the Bank of Israel and central banks all over the world is price stability in the economy."
How do you respond to that?
"Everyone can have their own opinion. Matter of fact, we already pointed out in the Bank of Israel report that the interest rate environment contributes about a fifth of the increase in housing prices. I have no doubt that the main component, both from our analysis and from discussions with contractors, people in the field personnel and the rest of those involved, is supply. This is the key and we see positive developments in the supply sector - more construction starts and permits. This is the key in the housing sector over time.
"Certainly, as interest rates rise, they will continue to cool the market to one degree or another, but interest rate increases cost households more and for sure young couples looking to enter this market. Even if the market cools, they still find themselves with higher payments.
"On the other hand, issues such as the ratio between monthly payments and income, or the amount of the loan in relation to the property's value (LTV, which today stands at up to 75% of the property's value) are among the most stringent. We are constantly examining the issue, and we see no need to make them even more stringent, because In the end, such a step will prevent certain populations from being able to enter the market. So with all due respect, I still stand by my opinion that the key to a solution in the housing market in the long term is of course on the supply side."
Published by Globes, Israel business news - en.globes.co.il - on October 4, 2022.
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