300,000 Israelis have been called up to the army reserves, schools and educational institutions throughout the country are closed and thousands of families are living in enormous uncertainty due to the nightmare events in southern Israel following the surprise attack by Hamas on Saturday morning. The circumstances of the war also create huge uncertainty, which will greatly impact Israel's economy.
A senior figure in Israel's economy told "Globes," "We are expecting to see a decrease in growth, private consumer activity will weaken as the war continues, and the government deficit will also widen due to higher spending and the fall in income."
Awaiting reaction from the government and Bank of Israel
One of the main questions these days is the possible effect of the war on the Gaza border on the rate of inflation, and accordingly also on the Bank of Israel's interest rate policy. "The initial effect is an increase in demand for the public needs, especially basic consumer goods," Bank Mizrahi Tefahot chief economist tells Globes. Menachem says that on the other hand, economic activity is affected, which leads to a smaller supply. This set of effects, Menachem says, will bring price rises in the short term.
Another factor that can fuel inflation is oil prices, which have already been rising in recent days. Oil prices tend to jump due to security developments in the Middle East, the increase in oil prices for Israel means an increase in the price of fuel directly, and indirectly an increase in the prices of imported goods. The increase in fuel prices will also lead to an increase in the cost of the war, which requires a lot of transportation, and also to increasing the burden on the public during war.
Menachem believes that in the medium term, the price rises could moderate, despite the rises in the short term: "The demand side will be adversely affected by the negative sentiment and the previous stocking up increases."
Menachem adds that at the moment it is difficult to decide where inflation will move, when the opposing forces are pulling with great force. According to him, much of this will depend on how the decision makers react and how much the government will support households and companies. This, in addition to the steps that the Bank of Israel will take to provide liquidity to the financial system.
Several industries are in danger
However, continued inflationary pressures are not the only scenario, especially not in the medium-long term. War is not a factor fueled by consumption. On the contrary, the situation will probably lead to a complete stoppage in several industries, such as tourism, which may later also lead to a slowdown and possibly even price decreases (deflation).
Oppenheimer Israel co-CEO Harel Gilon says, "When you look at the data of the mobilization of reserves, it is clear that economic activity is about to slow down." According to him, this is a very large share of the employment market which will lead to a slowdown in the economy. He explains that during the war, many industries actually cease to exist: "Tourism, restaurants and overseas travel simply stop and this is surely going to change the inflation situation that has been here so far, and actually lead to an economic slowdown."
How the war will influence the interest rate
On this point the experts disagree. Bank Hapoalim chief financial markets strategist Modi Shafrir tells "Globes," that looking into the past the Bank of Israel hiked the interest rate after the Second Lebanon War and he recounted that the war was the main reason for the rate hike. This despite "the devaluation of the shekel, even after the Bank of Israel's intervention plan, the increase in uncertainty and the history of the Second Lebanon War, increase the likelihood of an imminent interest rate hike on October 23rd".
On the other hand, Gilon believes the interest rate will fall due to the expected slowdown in the economy. Another source we spoke with estimates that due to the uncertainty the rate will remain unchanged "The interest rate is going to remain unchanged for a certain period, the Bank of Israel will have to manipulate the economic situation so as not to suffocate the economy." He adds that inflation seems too high to lower the rate, so the Bank of Israel will probably try to maintain the current interest rate and will operate in the foreign exchange market to try and balance shekel-dollar exchange rate volatility.
Of course, the rate in Israel is affected by several external factors as well as domestic factors. Among other things, one of the main factors that influence the Bank of Israel decision is closely related to the decisions of the US Federal Reserve. At this stage, in the US it is estimated that the Fed will not raise the rate at its next meeting, and will leave the interest rate in the US at its current level of 5.5% in the upper range. However, in view of the war in the south, it is still too early to know how the Bank of Israel will react.
How much will the war cost the Israeli economy?
Another significant economic question concerns the cost of the war. Shafrir says that based on an analysis of the costs of Operation Protective Edge and the Second Lebanon War, it can be estimated that "the costs of the current war will amount to at least 1.5% of GDP (at least NIS 27 billion). This means an increase in the fiscal deficit of at least 1.5% of GDP in the coming year."
More can be learned from Israel's most recent war, the Second Lebanon War. The war, in the summer of 2006, resulted in deflationary effects on the economy, when from an annual inflation of 3% during 2006, the economy saw negative inflation by the end of the year.
Published by Globes, Israel business news - en.globes.co.il - on October 11, 2023.
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