Deflation Raises Prospect That Bank of Israel Will Try to Tamp Down the Mighty Shekel

July consumer price index fell 0.3%, but home prices rose 0.5% amid signs that the market is heating up again

Shekel notes
Olivier Fitoussi

Israel’s consumer price index dropped much more sharply than expected for the second month in a row in July, but housing prices continued to rise with no sign that the trend will abate.

The Central Bureau of Statistics reported on Thursday that the July CPI fell 0.3% for the month. That was a bigger decline than economists had forecast – no change to a minus 0.1%.

The July figure followed an 0.6% drop in consumer prices in June and slashed the 12-month trailing rate for inflation to just 0.5%. Only two months earlier the 12-month rate has been 1.5%, inside the government’s target range of 1-3% annually and close to Bank of Israel Governor Amir Yaron’s target of 2%.

The inflation rate drop, together with the appreciation of the shekel this year, has caused the Bank of Israel to abandon plans to raise interest rates any time soon. Yaron said July 31 that “for an extended period of time there will be no decision to raise interest rates” and the latest data won’t change that.

However, the Bank of Israel still faces the problem of a strong shekel and that could lead it to intervene in the foreign currency market. An appreciating shekel weighs down on Israeli inflation by lowering the price of imported goods.

Although the dollar strengthened at the end of last week to a representative rate of 3.541 shekels, it remains down about 5.5% against the Israeli currency this week. The euro, which was fixed at 3.9248, has lost even more ground.

“If it seems that we are not meeting the inflation target – one of the causes being the shekel’s appreciation – and if it seems the exchange rate is moving away from what it should be according to the fundamentals of the economy, then we will go back to intervening in the foreign exchange market,” Andrew Abir, the central bank’s director of the market operations, told TheMarker last week.

Meanwhile, the government faces a wholly different problem vis-a-vis housing prices. The CBS reported on Thursday that they rose 0.5% for May-June, compared with April-May. That marked the fifth monthly gain and leaves the housing index just 0.2% below its September 2017 peak. Compared with a year ago, home prices were up 1.4% in May-June and they are up 3% in the first half of 2019, the CBS said.

The rise in home prices, which had started to turn around 18 months ago, is a blow to Finance Minister Moshe Kahlon. His Kulanu Party captured 10 seats in the 2015 election on the promise it would end a decade of soaring prices, but it fell to four in the April election and subsequently merged into Likud.

Raising the roof.

Kahlon spent billions of shekels on his Machir L’Mishtaken (Buyer’s Price) program that sold land to builders at discounted prices on condition they pass the savings on to buyers. But the program was too heavily concentrated in Israel’s northern and southern peripheries, where land is available but housing demand is limited.

Meanwhile, housing starts have been in decline, constraining future supply and increasingly the odds that prices will continue to climb. The number of building starts began to decline at the beginning of 2018 and in the year to March 31, 2019, dropped 2.1% to 48,310 unit.

More recently, it appears that consumers have lost confidence in the government’s ability to rein in home prices. That change is reflected in the mortgage market, where banks granted 6 billion shekels ($1.7 billion), a 3% increase from May and a 22% rise from June 2017.

Kahlon has admitted that Machir L’Mishtaken would not solve the fundamental problems of the housing market, but in the meantime the government has not devised any other plan and a new government is unlikely to be formed until later this year, meaning any initiatives will have to wait till 2020. The state is undertaking many urban renewal programs, but it will be years before the extra housing they produce come on line.