BoI struggles to explain negative inflation

Karnit Flug Photo: Reuters

The Bank of Israel advocates a theory that prices in Israel are in a long-term process of adjustment to the prevailing prices in Europe.

The new Bank of Israel monetary report published today gives the impression that it is having trouble explaining why inflation has vanished from Israel. The Bank of Israel continues to blame the government's policy of lowering the cost of living as an important factor in keeping inflation low, and also cites increased online purchases by Israelis. It also advocates a theory holding that prices in Israel are in a long-term process of adjustment to the prevailing prices in Europe.

The law requires the Bank of Israel to explain in its monetary report why the inflation rate deviated from the target established by the government for more than six consecutive months. According to the law, the Bank of Israel is required to lead a policy aimed at bringing inflation within the 1-3% target within two years. As of the end of June, however, inflation over the past 12 months has been minus 0.2%, after the June Consumer Price Index confounded expectations with a steep 0.7% drop.

The writers of the report prefer to focus on the positive rate of inflation in the first half of 2017, the first such positive rate since 2014. Looking ahead, however, inflation expectations reach the government target only in the medium and long term (over three years). Negligible inflation in Israel is particularly prominent in comparison with the euro bloc and the US, where prices have begun rising.

What makes the inflation mystery even more difficult to solve is the fact that wages in Israel are still rising, while energy prices, which previously made a substantial contribution to a decline in prices, rose 8% in the first half of the year.

The Bank of Israel lists four main reasons why inflation in Israel is low. The first is the shekel, which continued to strengthen in the first half of 2017, mainly as a result of the dollar's global weakness.

The second is "administrative decisions made by the government with the goal of reducing the cost of living." The Bank of Israel states that these decisions "continued to lead to lower prices, which contributed to a decline in inflation during the reviewed period." According to the Bank of Israel's economists, were it not for the government's measures for reducing the cost of living, the Consumer Price Index would have risen 0.9% in the 12 months ending in May.

A third reason mentioned in the monetary report is "The increased level of competition in the economy, which was partly the result of the increase in Internet purchases." The four reason listed is extremely vague: "According to an opinion voiced in the Committee, price levels in Israel may be going through a long-term adjustment to a level that characterizes developed markets in Europe."

With respect to developments in the real estate market, the Bank of Israel states that housing market figures indicate that prices have stabilized in recent months, while demand has cooled off and supply has continued to grow at a steady pace. Supporting this assessment is a low level of deals for new housing units and a substantial drop in the proportion of investors in deals. These developments were accompanied by a slide in the volume of new mortgages and a rise in the interest rate in comparison with the preceding six months, with some decrease in recent months.

The Bank of Israel states that the annualized rate of increase in housing prices slowed in the first half of 2017. Prices were up 4.5% in the 12 months ending in April, compared with 5.7% at the end of the preceding six-month period. Rents rose 1.6% in the past 12 months, and the rate of increase has been stable in recent years.

Published by Globes [online], Israel Business News - www.globes-online.com - on August 8, 2017

© Copyright of Globes Publisher Itonut (1983) Ltd. 2017

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Karnit Flug Photo: Reuters
Karnit Flug Photo: Reuters
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