Next Monday, the governor of the Bank of Israel, David Klein, will decide whether to raise interest rates or not; and the money market is saying to him: Put them up.

The short-term debt certificates (Makam) have shown a yield in the past few days of 8-9 percent, reflecting expectations of an interest rate hike of 1 or 2 percent; but the governor does not have to give in to the money market. He could look at the inflation expectations going around the capital market. There, he will find that these forecasts have risen and are currently floating around 6 percent, but this is really just the other side of the same coin.

So maybe this time he'll take the government's seriousness over budgetary policy as his leading light. Ten days ago, in a hysterical, disorganized meeting, Prime Minister Ariel Sharon and Finance Minister Silvan Shalom decided to cut a further NIS 2 billion from the budget. Then, last Monday, Shalom convinced Sharon that if he seriously wanted to keep the government's budget deficit to within 3 percent of GDP next year, they would have to trim NIS 4 billion from the 2003 budget - that is an extra billion to put the Rabinowitz tax reforms in place and another NIS 1 billion to improve infrastructure.

The trouble is that Klein is thinking of much higher sums altogether. He suggests that the government slash the budget by NIS 10 billion, half of which would be diverted to infrastructure. So, even according to this rule of thumb, he isn't pleased. And anyway, the final government decision on how much will be cut was postponed to July 21; and who knows what will happen then? According to all the signs, the numbers are in the ascendancy.

Of the last NIS 12 billion budget "cut", NIS 4.5 billion went toward enlarging the budget deficit, NIS 4 billion came in the form of raising taxes (including employer NII contributions) and only NIS 3.5 billion was a true cut in government expenditure and various state transfer payments. And of the NIS 4 billion from higher taxes, half of this comes from the increase in value added tax.

Back in July 1976, VAT was only 8 percent - a reasonable rate. But the rate has creeped up since then, eventually reaching the 18 percent it is at today - a highly unreasonable rate that just invites tax evasion, making such behavior quite justified in the public's view.

And how much will this latest 1 percent rise in VAT contribute to the CPI? The simple answer says 1 percent, but this is incorrect because if the price of an item increases from NIS 117 to NIS 118, this is only a 0.85 percent rise. And then again, not everything carries VAT. There is no VAT on rents, for example, or on second-hand cars, overseas travel, municipal taxes (arnona), fruit or vegetables, so the consumer price index should rise by only a few tenths of a percentage point.

On the other hand, there are many in the economy that are taking the opportunity of price instability to chuck in a few price rises anyway. On the other other hand, the economy is in a recession and demand is dropping, so traders are wary of raising prices. So what will happen in the end? Only June and July's inflation rates will tell.