“We believed that conditions were ripe.” Those were the words Acting Bank of Israel Governor Nadine Baudot-Trajtenberg used Monday to explain the central bank’s decision to raise its key lending rate to 0.25% from 0.1% after three years and nine months of no change.
Baudot-Trajtenberg acknowledged that the conditions required to raise interest rates have been in place for some time, but as she explained it, the monetary policy was to be sure those conditions were stable. By stable conditions, it meant that inflation will remain inside the government’s target range of 1% to 3% a year.
Keeping inflation inside the range is the central bank’s main policy goal. For the better part of a year, the bank has been saying its policy sought “to entrench the inflation environment within the target range” The fact that it didn’t repeat the phrase suggests that it now believes it has achieved that goal.
On what basis? The only risk the monetary committee pointed to was an exceptional appreciation of the shekel, which would lower the price of imported goods. But against that, there is the fact that unemployment is low, wages are rising and the government is running an expansionary fiscal policy.
All that, of course, has been true for several months and the bank didn’t act. Why now? Baudot-Trajtenberg said inflation was within the range, but still very low. “We believed we needed to be confident that inflation had really returned and had stabilized within the target range.”
Inflation has been in the target range, but it is has trended slightly down since August, from an annual 1.4% to 1.2%. But from Baudot-Trajtenberg’s perspective, it was enough that it stayed above 1% for an extended period.
Perhaps even more important, the monetary committee was looking at other measures of inflation besides the headline consumer price index.
One of those is the CPI taking out prices for energy and fresh fruits and vegetables as well as price reductions ordered by the government. Energy prices are set beyond Israel’s borders, in the global market, and are not affected by local factors. Fresh produce prices are volatile and seasonal and create CPI noise. Government intervention in prices, such as the housing market, also operates outside market dynamics.
That measure of inflation has moderated from an annual rise last June of 1.1%, heading lower to 0.8% in the next two months and then moving back up to the bottom end of the target as of October. It’s hard to see how that shows inflation has become entrenched in the range.
Another way the Bank of Israel looks at inflation is to separate tradable from untradable goods. Tradables are things that are imported or could be made locally as an import substitutes, like clothing and cars; untradables are things like property and internet connections or pedicures that can only be provided domestically.
Untradables account for nearly two-thirds of the CPI, and they have risen steadily in recent years at a rate of 1.3% to 1.9% annually. In October they rose 1.6%. Prices of tradables, on the other hand, have been falling. In April 2016, they were down an annual 3.6% and only showed a small rise in June, and by October they were up 0.5%.
But the only reason prices for tradables were rising was because of oil, while that of other tradable goods declined. Here, too, it’s hard to make a case for inflation entrenching itself.
Another way of looking at inflation is to see what inflation expectations are for the next 12 months. Although these have hovered at about 1%, they have also been trending lower. Among the economic forecasters polled by the Bank of Israel, the average fell from 1.1% in early October to 1.05% November 22. In the bond market, the imputed forecast CPI dropped from 1.31% to 1.05%
That is not a dramatic fall, but is it fair to call it entrenchment? Some economists, like Jonathan Katz of Leader Capital Markets, say yes; others are doubtful.
Katz correctly predicted a rate rise this week, but many other economists were sure the bank would hold off, if for no other reason than that the recent figures on economic growth have been disappointing. Ten days earlier, the Central Bureau of Statistics released a preliminary estimate of third-quarter gross domestic product that showed annualized growth of just 2.3%. Earlier quarters were revised downward.
Baudot-Trajtenberg acknowledged that. “The last two quarters registered moderate growth, even very moderate.” Nevertheless, she said that “according to more up-to-date indicators, we believe economic growth is continuing handsomely.”
Those indicators are the Bank of Israel’s S index, which showed a strong 0.3% rise in October. The problem is that the index is a composite of different parameters that don’t come in all the same time, this it is constantly being raised, sometime considerably.
The one economic parameter that has moved a lot over the weeks between the last rate decision and the previous one is the exchange rate. The shekel lost 3.6% in terms of the nominal effective exchange rate and by 3.2% against the dollar. The shekel’s weakness certainly contributed to the monetary committee’s decision.
But that may be what left so many economists dumbfounded. “Apart from the depreciation,” concluded Alex Zabezhinsky, chief economist at Meitav Dash Investments, “there’s been no change in the data justifying an increase in the interest rate, certainly not at this time.”
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