Consumer Prices Confound Analysts

'We're in big trouble,' says Shlomo Maoz, chief economist of Excellence Nessuah investment house, commenting on the unexpected rise in the consumer price index (CPI) for March.

The consumer price index (CPI) for March rose by 0.3%, confounding earlier assessments that the index, which is an inflationary indicator that measures the change in the cost of a fixed basket of products and services, would drop.

"We're in big trouble," says Shlomo Maoz, chief economist of Excellence Nessuah investment house, commenting on the unexpected results for March. He for one had predicted that the CPI wouldn't budge in March.

Analysts had mostly projected that the CPI would retreat -0.2% or -0.3% last month. The actual figure indicates that inflation is running higher than had been believed.

Moreover, the steep increase jeopardizes the Bank of Israel's assessment that annual inflation is running between 2% to 3%, which would be within the government's target range.

The spike in March inflation comes on the heels of February's low rate of -0.2%.

One of the factors lifting the CPI last month was foodstuffs. The index of food rose by 1.6%, while the index of consumer prices for transportation and communications gained 1%.

The housing index, which is considered to be relatively sensitive to the exchange rate of the shekel, rose 0.4% in March. Transportation, communications and housing are all heavyweight items in the CPI, meaning that any change in them sways the whole general index.

On the other hand, the price of fresh vegetables fell by 13.4% in March and clothing retreated by nearly 5%. However, these items carry relatively small weight in the index.

The consumer price index has risen by just 0.1% since the beginning of the year, but it's risen by 3.7% over the past 12 months, which is well beyond the government's inflation target range. Trend data indicates that the index is rising at an annual rate of 3.3%, which means that the Bank of Israel seems to be missing its inflation target again, this time on the upside.

In addition to the 10 sub-indexes of the CPI, wholesale prices of manufacturing output for the domestic market also rose by 2.2%, and prices of residential building output increased by 0.3%.

Grit your teeth

"High inflation is not a problem just in Israel, but all over the world, and it is driven by the rising price of food and energy world wide, so there is not a lot to do about it other than grit one's teeth," Maoz said. "This situation will continue so long as interest rates in the U.S. remain low."

Maoz is referring to the trap in which the U.S. finds itself. On the one hand, the Federal Reserve would like to stimulate the economy - but lowering interest rates stimulates inflation. And that means rising prices.

Israel is caught in a similar trap, Maoz believes. Cutting interest rates would weaken the shekel, which the manufacturers badly want. But it would also stimulate inflation. Raising interest rates will rein in inflation but strengthen the shekel.

"The Bank of Israel can't raise interest rates because that would strengthen the shekel even more. In turn that would hurt the state's income from tax," Maoz explains.

He expects Bank of Israel interest rates to rise to 4.5% a year from now, from their present level of 3.5%.

Harel's head of economics and research, Dr. Michael Sarel, suspects that the sharp rise in the consumer price index may force the Bank of Israel to change its recent assessments that the pace of inflation is expected to decrease, an assessment that Sarel does not share.

"The housing component surprisingly rose by 0.4%, in spite of the dollar falling by 2.3% during the same period. We estimated that housing had eroded compared to other prices in recent months, and expected an upward correction. It looks like that is what is happening," Sarel added.

He thinks it unlikely that the central bank will be lowering Israeli interest rates any more for the time being. If anything, he thinks the bank will be likely to start jacking the rate back upward, unless the shekel continues to appreciate against world currencies.