Negative June CPI Foretells Slowdown

Consumers are hesitating to spend.

The 0.3% drop in the Consumer Price Index for June indicates that the economy has entered a new phase and is slowing down.

Actually, warning signs had been evident for months but policymakers at the Finance Ministry and the Bank of Israel refused to acknowledge them. Now the flashing red lights are evident to them as well.

The negative June index, undercutting analyst expectations of a 0.1% rise, ended any illusions. The signs of economic weakness are clear.

June indices are generally positive: up 0.4% last year, 0.3% in 2010, and 0.9% in 2009; it last fell in 2003 - by 0.6%. But more telling is the CPI trend over recent months.

Since last September, when the index fell 0.2%, there have only been three months when it went up: in October by 0.3%, in March by 0.4%, and in April - influenced by the Passover holiday - when it rose 0.9% and slightly bamboozled analysts.

But in November the index edged down 0.1%, followed by several months registering zero change: in December through February, and again in May. Last month's 0.3% drop indicates that demand has dried up and that prices are either treading water or beginning to sink. Money isn't flowing: The public either suspects or knows that difficult times lie ahead and is holding on tight.

The index gained 1.0% in the first half of this year and rose by the same 1.0% since June 2011. The trend indicated by the last four months points to an inflation rate of just 0.6% - less than the government's 1% to 3% annual inflation target band, and well under the central bank governor's 2% objective.

Such an inflation rate attests to weakness and the onset of economic slowdown - not to the 3.1% growth this year and 3.4% growth in 2013 that were promised, but much slower growth.

How much slower? That's something we'll begin to comprehend in the coming days.

A drop in demand leads to decreasing prices and to the index falling. Only housing costs, not reflected in the CPI, keep rising - as the cost-of-living demonstrations rage on.

The June index brings us to a crossroads. The treasury's fiscal policymakers and the central bank's monetary policymakers will need to reassess their course of action. Talks over the government budget for the following year are usually going strong at this point in a normal year.

This year the treasury is still laboring over preparing the budget: over cutbacks on one hand and tax increases on the other. The June index will oblige the treasury's budgets department and the prime minister and his advisers to take into account that the economy is shifting directions - toward a slowdown, and perhaps even a recession down the road.

The considerations that have guided the policymakers until now, as well as the complacency exhibited by the Prime Minister's Office and the finance minister, must change.

They'll need to do some reevaluating at the Bank of Israel too. Unlike during last economic crisis, governor Stanley Fischer now has an advisory committee at his side with three renowned economics professors.

The objections voiced by the governor, as well as the treasury's budget director and accountant general, against raising the government's deficit target to 3% of the gross domestic product now sound clearer and more convincing. It still isn't too late.

Anyone who believed, at least until the June index was announced Sunday, that the central bank shouldn't lower interest rates before the end of the year certainly changed their mind. It is very likely that the governor won't wait until the end of the month to lower rates - as a signal to the public, the prime minister, and the treasury that times have changed. And more measures are expected to be taken.