Opinion |

The Bank of Israel Yanks Away the Punchbowl

The party would have likely ended anyway as the Ukraine war and other threats rear their heads

David Rosenberg
David Rosenberg
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Bye bye
Bye byeCredit: Tomer Appelbaum
David Rosenberg
David Rosenberg

If you read everything the Bank of Israel said and wrote on Monday when it raised its base lending rate for the first time in three years, the only problem the Israeli economy has is an excess of riches.

Without a doubt, Israel is partying hearty. The economy grew 8.2 percent in 2021, and double that in the final quarter of last year. Much of that is thanks to a COVID-recession rebound, but the Bank of Israel is forecasting quite impressive growth rates of 5.5 percent and 4 percent this year and next, too. It predicts the unemployment rate will fall to a historic low of 3.5 percent this year and the government’s budget deficit to a mere 1.4 percent.

“We continue to see a robust Israeli economy that has nearly completely erased the effects of the pandemic,” Governor Amir Yaron told a news conference.

The only pooper at this party, he said, is the consumer price index, and it really isn’t much of one: After years of little or no inflation, the CPI has risen 3.5 percent, but that’s nothing compared to the 7.9 percent in the United States and 5.9 percent in the eurozone. Anyhow, the Bank of Israel believes Israeli inflation will fall back to a comfortable 2 percent in 2023. The central bank is confident that despite a tight labor market, wages won’t rise quickly enough to pressure prices higher.

Raising its base rate by 25 basis points to 0.35 percent is supposed to be the first step in removing that proverbial punchbowl. Its' a signal to the party-goers that the fun is over. Next, the governor will lift the bowl up, carry it into the kitchen and dump its contents into the sink.

In other words, this is the beginning of a series of hikes that will bring the Bank of Israel rate to 1.5 percent in a year from now.

Why? To take some of the wind out of the mortgage market, which has caused home prices to soar 13 percent in the past year; and to make it more costly for businesses and consumers to borrow, thereby taking some of the wind out of the rest of the economy, too.

Normally a rate rise would also cause the shekel to strengthen and make life difficult for exporters. But other countries, coping with higher inflation than Israel, will be hiking their interest rates faster than Israel, so the interest rate differential will, if anything, widen in Israel's favor. Yaron isn’t concerned about inflicting that kind of blow.

The Bank of Israel has been accused (by myself, among others) of reacting too slowly to events. It didn’t see how quickly the economy was bouncing back from the coronavirus pandemic or the inflation threat that emerged in the waning months of 2021. Now, it may be reacting too slowly to the latest events, namely the war in Ukraine, the loss of the government’s Knesset majority and the rising tide of violence in the West Bank and Israel.

None of these things have crashed the Israeli economy’s party, but each in their own way threatens to subsume the inflation problem with the problem of sustaining economic growth or even warding off recession.

Elusive recovery

Let’s start with Ukraine. Compared to much of the world economy, and certainly compared to Europe, the war is having little impact on Israel. Russia and Ukraine account for a bare 1 percent of Israel’s foreign trade.

We may even benefit from the war now that Belarussian potash has been sanctioned, opening up new export opportunities for our own potash. Defense exports are expected to soar as Europe rearms. Some think Europe might even want to buy our natural gas to replace Russian imports, though infrastructure would have to be built first.

But there are real risks that could easily swamp any of these benefits. A sharp slowdown in the world economy and trade is already underway. The odds are that the war will last for some time as Russia pursues an increasingly difficult victory; sanctions will impact even longer since it’s hard to see the West dropping them even after the fighting stops. Global recovery will remain elusive for some time to come.

But there are real risks that could easily swamp any of these benefits. A sharp slowdown in the world economy and trade is already underway. The odds are that the war will last for some time as Russia pursues an increasingly difficult victory; sanctions will impact even longer since it’s hard to see the West dropping them even after the fighting stops. Global recovery will remain elusive for some time to come.

The loss of the government’s Knesset majority also poses a danger to the economy. Even if Prime Minister Naftali Bennett’s coalition manages to hold on to power, its ability to pass legislative reforms and the 2023 budget is now zero. We’re back to political paralysis that could last for an extended period, especially if the next election produces the same kind of stalemates the previous four did. Israel could be set for months, even years, of lame-duck and caretaker governments.

The threat of political paralysis can easily be overstated. In 2019-20, the economy managed to overcome it, even though it was contending with the COVID pandemic. Israel has a budget at least for 2022. But the damage political paralysis wreaks grows the longer it lasts, especially if businesses and consumers perceive it as business as usual, not something that will eventually be resolved. I challenge anyone to imagine a realistic scenario for how it will end.

Finally, there’s the security threat, which is the biggest black box of them all.

The series of Palestinian attacks in the last three weeks and growing clashes between the army and Palestinians in the West Bank is a worrying development. But how many times have we been told we’re on the cusp of a third intifada only to see the wave of violence fade away? Then again, no one predicted the first or second intifadas.

A little mercy is due Yaron and the Bank of Israel’s monetary committee. It’s hard to keep up with changes in the political sphere, which more often than not appear in a flash and whose repercussions take time to sort out. Who knew that Vladimir Putin would order troops into Ukraine, that Knesset member Idit Silman would decide she couldn’t remain in the government, or that Mohammed Abu al-Kiyan would actualize his support of ISIS by a stabbing and ramming attack in Be’er Sheva?

Yaron acknowledged all of these dangers (and added recurrent COVID to his list as well), but he didn’t make much mention of them. That may be his way of comforting the economy at a time when he is taking away the punchbowl. But, given his record, it may be showing us yet again that he isn’t thinking forwardly enough.

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