The 0.7% drop in the Consumer Price Index in February looks almost like a carbon copy of January, when the CPI fell 0.9%. As in January, it was mainly a decline in energy prices that tilted the index downwards, and, as then, the general assessment is that we are seeing one-time effects that do not indicate deflation or a recession, but result from global developments.
The Bank of Israel has still not published figures on inflation expectations, so that it is hard to calculate the prevailing effective interest rate. It is clear though that the real interest rate is positive, and even rather higher than 1%. Even so, it is not to be expected that the Bank of Israel will decide to redouble its efforts to raise the rate of inflation. Such a decision would lead to the use of quantitative easing, since the interest rate tool has just about done all it can.
The assessment that the Bank of Israel will not see any need for new decisions on monetary policy rests, as mentioned, on the assumption that the change in prices stems from one-time factors. If we add to that the acceleration in economic activity in the fourth quarter of 2014, and the expected positive consequence of the depreciation in the effective shekel exchange rate in recent weeks, then it would appear that the Bank of Israel will not find it hard to decide on maintaining current monetary policy.
That assessment must however be qualified, at least when we look at the long term. The conclusion that the CPI fell because of overseas developments hides more basic processes. True, energy and commodity prices are pushing the CPI downwards, but the question is, why aren't other prices rising enough to offset the full effect of these declines? On the face of it, the depreciation of the shekel ought to be a factor raising prices, and there has been some revival of private consumption. The fact that this has not registered will almost certainly affect the shaping of inflation expectations, especially for the year ahead. If these expectations continue falling, and if the economy shows signs of weakness in the second quarter, the Bank of Israel will be back to where it was a month ago. In other words, the central bank can enjoy a few quiet months, but it could be that later on it will face a difficult dilemma about the future of its monetary policy.
Published by Globes [online], Israel business news - www.globes-online.com - on March 16, 2015
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