After the sharpest interest rate rise seen in Israel for over 20 years, rates are still low historically speaking at 2%. But the hikes are not over. In order to restrain inflation, the Bank of Israel is expected to continue pushing up the interest rate, even if there are already signs that price rises are moderating. Meanwhile housing prices continue to soar. Bank of Israel Deputy Governor Andrew Abir tells "Globes" in an interview that it is not housing prices at the top of the agenda. That problem he leaves to the government. The main concern behind yesterday's 0.75% rate hike is the spreading of inflation to parts of the economy beyond energy and imported commodities.
Much has been said in the media about the fact that the Bank of Israel should raise interest rates to cool real estate price increases. You have argued over the years that interest rates are not a significant factor in housing price increases. Has this opinion changed?
"We do not have a mandate to act to lower real estate prices. Our target is the inflation range. As for what causes increases in the real estate market, and there have certainly been very sharp increases over the past year, our problem is that first and foremost what affects the price of real estate is supply. The interest rate is secondary. It's not that it doesn't have an effect on real estate prices, but on a smaller scale than the supply factor. There is a need to build over 60,000 apartments every year and certainty that it will continue like that for five years. It's not enough to show building starts for one year because people don't buy this story. They want to see 5-10 year plans, in which they build enough apartments to meet future demand with population growth. This means building a city the size of Modi'in every year. This is a serious challenge that the government needs to take on and it is taking steps, but it needs to take long-term steps and then I think we will see a moderation in housing prices."
Aren't you concerned that the rate hike will in practice act more strongly in repressing real estate supply? The rate hike after all makes more expensive and reduced the credit options for contractors. So isn't it possible that there rate hikes will accentuate future problems on the housing supply side?
"I think that this is marginal. The main story is demand and the main story of this is population growth. If you don't build enough homes, whether it's for rent or for buying, then you won't solve the problem."
Does your focus only on the inflation target of the Consumer Price Index, ignoring other indicators like housing, not require rethinking?
"I don't think so. Everyone should do what they are able to do with the tools at their disposal." He adds humorously, "In principle, it is possible to raise interest rates to 20%, bring the economy into a deep recession and then it will affect real estate prices, although this is not an ideal situation. Let them build more houses and the interest rate will not be excessive and young people will be able to buy apartments and their mortgages will not be so high."
"If the rate today was 5%, our response would have been different"
You cannot ignore the impression that the Bank of Israel succumbed to the politicians by approving a two-thirds variable rate component for mortgages. There are no free lunches and the banks warned on this. Did you not get carried away by anti-banking populism?
"Everyone who takes a mortgage need to take into account that part of the repayments can rise. Mortgage advisors must explain this to the public. It's possible that the public put too much emphasis on next month's repayment and not what will be in another five years. True they hope that their salaries will rise over these years but it's possible that prime interest rates will be higher because interest rates today are very low. There is no doubt that our decision to put rates up by 0.75% is a function of the current level of interest. If the rate today had been 5%, our response would have been different. The interest rate of mortgages historically speaking is relatively very low."
According to the Bank of Israel, the sharp appreciation of the shekel, models is equivalent to an interest rate hike of 1.5%. Why do you feel the need to add to this sharp tightening that comes from the currency by also raising the interest rate by 0.75%?
"The background to our decision to raise interest rates by 0.75%, more than the previous increase, is the data we received showing that the economy is in good shape, demand is strong, there are wage increases, rent increases, and the economy is heating, up as we saw in the rise of inflation to 5.2%. The cause is not only supply disruptions but also domestic factors. If you look at the non-tradable factors, there was an increase beyond our forecasts, so we decided to increase the pace of interest rate hikes. On the currency appreciation recorded over the last month, it followed a period of depreciation, and we still see a depreciation from the level at which we started the year. And we also don't know where the stock market is going, it is very bound up with world stock markets. If I could tell where the stock market was going, I could make a better decision, but we simply don't know."
From the interviews that Bank of Israel Governor Amir Yaron gave to Israeli television stations yesterday, it appears that the terminal interest rate will be 2.75%-3%, according to the Research Department, and that what you did yesterday was to speed up the pace at which you will reach this target. Can you explain the thinking behind the need to speed up the rate hikes, and do you share the Governor's opinion that 2.75% is still the terminal target?
"We don't have an interest rate target. The Governor was referring to the forecast of the Research Department regarding where they think the interest rate will be in another year, at the end of the third quarter of 2023, a forecast in line with the return of inflation to the target range. This is the forecast of the Research Department and certainly not the target of the Monetary Committee. Regarding Front Loading, this is necessary to bring inflation back down to the target range. We see an economy in very good shape, full employment, unemployment is at historic lows, and all these support Front Loading."
In the forecast published with the July interest rate decision, the Research Department expected us to end 2022 with inflation of 4.5% and the forecast for 2023 was 2.4%. But this forecast was with a barrel of oil at $105, compared with $90 today and with the shekel at NIS 3.50/$, compared with NIS 3.29/$ today. And it seems that according to the pricing of the capital market, inflation forecasts are falling together with these falls in commodity prices and in the shekel-dollar rate. So what has changed for the Bank of Israel since the previous meeting? In the past you have said that one CPI reading is not sufficient to prompt action by the Bank of Israel, but the aforementioned factors indicate a future moderation in inflation?
"The increase in inflation is spreading, even to sectors that are not imported and not energy, and it has spread to non-tradable products such as services, including rent inflation, and an increase in wages. We think that at some point there will be a slowdown in inflation originating from the supply side. We want to make sure that the markets in which inflation exists don't pass it on to other markets, putting us in a dynamic in which it will be difficult to bring inflation back down to the target range. If we don't react now, the price that citizens will pay will be higher later. It is better to act aggressively now to bring inflation back within the target range."
"We have enough measures showing that the economy is in good shape"
Could it be that the inflation measured by the Central Bureau of Statistics, as well as the update of the national accounts this month, caused the Bank of Israel to delay in responding? Rents and air fares were a surprise in this month's figures, but those who live here were experiencing the rises months ago.
"I don't think this is the reason. We're not looking at one quarter but at the pace of the last four quarters. One quarter can be very volatile and then there are corrections. We have enough indicators to show that the economy is in good shape. We can see that the economy is already in a good state from the latest indicators, Whether it's credit card purchases, or trips abroad, restaurant reservations, it's quite clear that there is demand in the economy. What changed the picture is the situation in Ukraine, but even without that the state of the economy would have led us to raise interest rates."
If we look ahead, the fall in oil prices has wiped out the rises resulting from the war in Ukraine, which supports the return of inflation to the target range. Is this what the Bank of Israel sees?
"I assume that over the coming months there will be an effect from the fall in oil prices and commodity prices, which will moderate price rises, but what concerns us is that the energy and commodity prices shouldn't filter through into other areas, which would make it very difficult to put the genie back into the inflationary bottle. So it is important to raise the interest rate now in order to avoid the dynamics of inflation rolling onto other areas."
Published by Globes, Israel business news - en.globes.co.il - on August 23, 2022.
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