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Analysis Oops, Did I Mention the Negative?

Every month, the banks and the investment houses release their forecasts for the following month's inflation figures. The problem is that some people take these predictions seriously.

Every month, the banks and the investment houses release their forecasts for the following month's inflation figures. The problem is that some people take these predictions seriously. The banks and the investment houses don't send pollsters out into the streets, the shops and the markets to check what prices are up to. That would be far too costly. They leave that up to the Central Bureau of Statistics. What they do do, at best, is run an econometric model, and at worst, employ some economist, who sits, ponders a little, and comes up with a number. What's bad about that? He could, if he's lucky, pick the right number!

So yet again this month, we see the little connection there is between the forecasts and reality. Everyone, without exception, expected a rise in the inflation figures. Bank Hapoalim forecast an increase of 0.4 percent; Menora Gaon expected 0.6 percent; Israel Discount Bank foresaw 0.5 percent; and the others predicted similar rises. But in the end, September's inflation dropped by 0.5 percent.

There were also reports that with the expected rise in the CPI, the governor of the Bank of Israel would moderate his cut in the interest rate, reducing it by just 0.3 percentage points. Did someone from the media speak to him? No. And if they had, would the governor have told him something? Of course not. This is a top secret matter, and debates on next month's interest rate have not even started; in any case, the bank is on its Sukkot holiday.

Despite this, we can surely expect the reports in the press to predict that David Klein will revert to a stronger interest reduction - 0.5 percentage points - because the CPI has taken us all by surprise and fallen. But these reports, too, will be based on the whims of treasury and banking staff, not on anything concrete.

When the banks and the investment houses tried to explain during the week why September's inflation rate was (they thought) going up, they cited the shekel's depreciation against the dollar and how this impacted on prices of housing and foreign travel, adding that there was a seasonal rise in fruit, vegetables, clothing and shoes.

Now that sounds reasonable (no-one accuses the forecasters of being unreasonable), but they forgot to factor in one small variable - the deep and cruel recession that is pushing demand down and is not allowing traders to raise their prices.

The housing index did indeed rise by 0.5 percent (a temporary rise, in my opinion); but in almost every other field, prices dropped sharply - because of the recession. Prices of clothing and footwear went down 4.2 percent; vacations were 2.5 percent cheaper; and telephone services dropped 8.5 percent - bringing the total CPI to a sharp drop.

Since the beginning of the year, prices have fallen by 1.5 percent, so it is likely that we will suffer negative inflation in 2003 too. This will boost the claims of the hordes that monetary policy has been too strict. The Bank of Israel's aim is "price stability" of 1-3 percent inflation. So negative inflation is a failure of policy. It proves that the bank's interest rate is too high.

We clearly do not expect the bank governor to hit bulls-eye of 2 percent, but we can expect him to take notice of the criticism leveled at him for some time, and to cut the prime lending rate further and faster, thereby making it easier for everyone in the private sector choking under a burden of high interest rates and low exchange rates. And a faster cut in interest will not harm his inflation target; instead, it will bring it nearer to the minimum of its target range of "price stability."