Look back with satisfaction, but ahead with concern. This simplistic saying might sum up the state of the economy when the Bank of Israel decided last week against lowering the interest rate. The Israeli economy continues to grow at a pace more or less commensurate with its potential, but the political paralysis and the widening deficit are creating great uncertainty about the future.
These factors resulted in the Bank of Israel's unexpected decision to put aside its interest rate tool and start doing what Governor of the Bank of Israel Prof. Amir Yaron has not done until now - start buying dollars.
No crisis
This complex picture is also indicated by the economic figures published in recent days. Unemployment fell to 3.4% in October. It is true that the number of jobs in Israel fell, and the increase in available jobs came to a halt. It is also true that October was a difficult month because a lot of it was taken up by the Jewish holidays. Still, an economy in which unemployment is at an all-time low is not in a crisis.
The growth estimates published last week tell the same story. It is true that high third quarter growth is attributable to the marginal factor of an exceptional jump in inventory. It is also true that imports of vehicles distorted the picture. Still, an economy growing at a 4.1% clip, or even 3.1%, if vehicle imports are excluded, is not in a crisis.
The strong shekel is exerting downward pressure on inflation and detracting from profits in sectors such as exports of goods. Still, a country whose currency appreciates 9% against the basket of currencies in less than a year and was among the few currencies in the world to gain ground against the dollar is not in a crisis.
Figures for household income and spending were published yesterday. Income gaps widened, reversing a three-year trend. Still, family income in Israel grew at a faster rate than spending, the standard of living rose, wages continued to climb, and Israelis have begun flying overseas even in November. True, the cost of living in Israel is still high, but the problem is much less acute than it has been in the past.
Housing prices index versus housing index
The struggle against higher housing prices was one of the issues emphasized by Minister of Finance Moshe Kahlon. The increase has been much more moderate in recent years, but it is feared that the upward trend is going to resume in full force. The rate of construction is not keeping pace with demand, while mortgage interest rates are low, which is encouraging people to take loans. If the Buyer Fixed Price Plan is terminated, or if investors return to the market, we will see a renewal of price increases.
The most surprising figure published is the increase in inequality. One of Kahlon's prominent successes as minister of finance was the fall in the inequality indices. During his term, the Gini inequality index fell for three consecutive years. Israel which had one of the highest scores on this index in the OECD, after Hong Kong, Mexico, and the US, reached the middle of the table in 2018. The new figures published indicate a widening of gaps and enrichment of the top 10% of income earners. The figures, however, were affected by a very exceptional one-time event in 2018 - a campaign by the Israel Tax Authority that enabled controlling shareholders in companies to pay reduced income tax on dividends withdrawn from their companies. The volume of these withdrawals was huge - nearly NIS 100 billion, on the basis of the fact that almost NIS 20 billion in tax was paid.
The bottom line is that the situation of Israelis improved, even if the extent of the improvement was unequal.
Yaron has ammunition, but when will he shoot?
All this applies to the past; the future is far less clear. The level of anxiety in the global economy has declined. It is true that the global growth forecasts were downwardly revised last week, but fear of a real catastrophe is fading. The dire scenarios of Brexit and a global trade war have lost some momentum in recent days. The Conservatives have a comfortable lead in the UK polls, and the approaching 2020 US presidential elections are taking away any stomach that Trump might have for starting wars. The world's central banks are signaling that they have finished cutting interest rates.
Just when it appeared that the international horizon was clearing up, however, storm clouds are gathering in local skies. How long can the economy go on growing as if there were no political paralysis? How long can the disconnect between record tourism, the strong shekel, flourishing exports, and security escalation continue?
The unemployment rate in Israel
It can be assumed that Yaron finds these questions disturbing. The markets expected him to lower the interest rate, mainly because inflation in Israel is waning, and Yaron had previously said that the Bank of Israel would cut the interest rate if it believed that the downtrend in the inflation rate was not temporary. Inflation has since continued its downward path, and its core elements - those not affected by background noise, such as fluctuation in the global markets and other exogenous factors - fell to 0.5%, far below the lower bound of the government's price stability target range.
For the first time since 2015, most analysts believed that it would happen this time. They regarded Yaron as a dove on interest rate policy and a hawk on intervention in the foreign currency markets. Yaron, however, confounded them on both counts: he did not lower the interest rate, and he bought foreign currency.
Foreign currency was purchased for lack of choice; otherwise, the shekel would have continued to strengthen, and inflation would have fallen even further. The Bank of Israel has been in the markets for two days now. The speculators and investors are testing his determination and examining his capabilities. This is a real test for Yaron, who is being careful to maintain constructive ambiguity, and has not set clear red lines, below which he will not allow the shekel exchange rates to fall.
In a scenario of elections in March 2020, the new budget will be approved only around September-October, at best, if decisive election results are obtained on the third time around, and a stable and responsible government is formed.
Postponing addressing the budget deficit will unsettle the market. Meanwhile, the state will work on the basis of the continuation budget. This may be good for restraining spending, but it is likely to detract from growth. The government is the economy's largest engine, and starting on January 1, it will be working at half speed. There will be no money for new undertakings, tenders will be frozen, and bulldozers will be stopped in their tracks. The impact of the slowdown will be felt on all sides. Unemployment will almost certainly rise, and inflation is likely to fall still further.
Yaron realizes that he must save ammunition for the coming months. His interest rate magazine has only a few bullets left in it before the rate moves into hazardous negative territory. His gun will still go off, but only in a fourth or fifth act.
Published by Globes, Israel business news - en.globes.co.il - on November 27, 2019
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