Inflation is climbing to new heights in OECD countries and the UK has already raised interest rates with the US Federal Reserve expected to follow suit soon. Israel has relatively low inflation but the IMF report on Israel published on Sunday stressed that Israel is not immune from global inflation, although it praised the Bank of Israel for successfully maintaining a low inflation environment but suggested it should be open to the option of also raising interest rates here.
Bank of Israel deputy governor Andrew Abir is not fazed by such warnings and told "Globes" that the Bank of Israel is content to be patient before altering course on monetary policy, even if inflation exceeds the target range of 1%-3% annually.
"We are not in the situation of other countries"
Abir explained, "What we see around the world is that there is a difference in how countries are coming out of the crisis. The biggest differences between countries that is influencing their policies is inflation. There are countries in which inflation has exceeded the target range, and reached 7%, and some of them have already begun raising interest rates, like Poland the Czech Republic, which raised rates by 50 basis points in one go, but this is because inflation exceeded their range. There are countries like China that are going in the opposite direction and cutting rates and easing their monetary conditions. We in Israel are in a somewhat different situation. Our inflation is 2.8% and still within our target range. Even if we see indices that bring inflation above the range, our expectation is that inflation in the second half of 2022 will fall in the direction of the target range.
"This lets us be more patient about tightening our monetary conditions and so we are not in the same situation as other countries. Of course we have to look at what is happening and it could be that we will be influenced by the strength of inflation overseas and we will have to behave accordingly. Everybody conducts monetary policy according to what is happening in its economy.
Abir is not concerned about recent price rises announced in Israel and others that were announced and cancelled.
He said, "It will bring about a 0.1% change plus or minus in inflation. What continues to influence is the price of fuel, which has surprised everyone and is continuing to rise and contribute to inflation. What we are looking at is salary pressures that are impacting prices but they are reasonable."
"The cost of living and inflation aren't the same thing"
Abir added, "We don't look at the price of products but inflation of products, and these are two different things. The solution to the cost of living is not related to inflation, which is an expression of salary pressures, which is itself expressed in supply and demand of products. If we see a surplus in demand in the economy, or perhaps because of a bottleneck, then you need to tighten the monetary policy. That's something that is possible to talk about but it is not connected to the cost of living.
"We are in a situation which is very comfortable for us and we don't feel that we have missed the boat. Our inflation is very low compared with other countries. You have to distinguish between the cost of living and inflation, which are two different concepts. There are structural reasons for the cost of living in Israel, which is higher than in other countries, and these are factors unrelated to the rise in the price of fuel in recent months globally.
"It's possible to see this in the most simple terms in supermarkets in Israel compared with overseas, and I think that the government has begun dealing with this issue, and there will be more competition. There are other more dominant products in the consumer basket, including housing and transport. In comparison with salaries in the economy, housing is expensive in Israel and the long-term solution is the constant handling of the supply side. We need to build 60,000 housing units every year and as long as we are not doing that, then the pressures on housing will increase."
Haven't low interest rates been part of the meteoric rise in housing prices?
"The ideal situation is that they will build enough apartments and the cost of mortgages will be low for young couples. It's possible to raise the price of the mortgage, the interest rate, and then young couples wouldn't be able to buy apartments, and that would bring about a fall in prices, and so what would you have achieved by that? You've caused problems, not only for young couples that want to buy but also for those who have taken variable rate mortgages. The genuine solution is simply to build more apartments. As soon as there is certainty in the market about government plans, and it starts implementing them, prices will adjust themselves, and you won't have to wait two or three years. They have to be sure that there is a real plan to increase the housing supply.
"Another major issue is transport. The solution is not necessarily to reduce taxes but to provide inexpensive public transport that is available for everyone. Here too the government is trying to allocate resources. It is important that you don't let the price of cottage cheese distract us from the more substantial things in the consumer basket. You have to pay attention to these structural problems."
The Bank of Israel's forecast sees a fall in inflation next year and this forms the basis for the Bank of Israel's reluctance to raise rates. But meanwhile the capital market has priced in three rate rises. This means that the markets believe that the Bank of Israel forecast is wrong.
Abir said, "The market also thinks that there will be a decline in inflation in 2022, compared with 2021. We don't see any difference between the forecasts of the financial markets and our forecasts, in which there will be a fall in inflation. The reason that will lead to a fall in inflation is very technical. We are always thinking about what should be the right response for monetary policy in the economy, and at the moment we think it should be patience, but we will see as we move forward what the right response will be to inflationary pressures."
Is a reduction in foreign currency purchases on the way?
The IMF has recommended that Israel reduce its foreign currency purchases if inflationary pressure continue. But this recommendation is unlikely to prevent future foreign currency purchases in situations where the shekel is sharply appreciating.
Abir remarked, "They are talking about a situation in which inflation is exceeding our target, then this is a reason to moderate use of this, and I don't think there is any argument between us on this. We are looking at several parameters, like growth, in order to know what tools to use at any moment. There are periods when the most suitable tool to operate is foreign currency intervention and there are periods when other tools are used. We have proved during the crisis that we have a broad arsenal of weapons for every situation."
Published by Globes, Israel business news - en.globes.co.il - on February 8, 2022.
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