The Bottom Line / The End of the Inflation Era

Inflation hit 5.5% over the past 12 months. This is not just very high, it is surprisingly so.

Inflation hit 5.5% over the past 12 months. This is not just very high, it is surprisingly so, well beyond the cabinet's annual inflation target of 1% to 3%. In fact, over the last three months it was even higher, 5.8% in annual terms.

In normal times, those of a stable, growing, developing economy, the headlines would be screaming about the return of high inflation.

In normal times, the governor of the Bank of Israel, Stanley Fischer, would have coordinated attempts to halt inflation with a drastic interest rate hike.

But these are not normal times. We are in the midst of a worldwide economic crisis, one that is slowly but steadily approaching us.

The inflationary period, around the world and here in Israel, is over for now. The October CPI, which rose 0.1%, just represents a short transition period - the end of one era and the begining of the next.

Israel is switching from a short period of inflation to one of falling prices, deflation, for an indefinite length of time. After the October consumer price index comes the November CPI, and preliminary forecasts are that it will be down 0.3%, followed by several low, or negative, indexes. These will show that Israel has moved into an era of deflation.

That is why Fischer rushed to lower interest rates in the last month and a half by 1.25%, and all the signs point to another 0.25% drop next week.

The huge crisis in world - and Israeli - financial markets has now started to hit the rest of the economy, and hard. That is why the Finance Ministry will finally announce tomorrow an economic stimulus plan.

The signs of recession are already here. While the October CPI may have risen 0.1%, two other important indexes, the wholesale price index for local industrial production and the price index for residential building, both fell sharply: 1.5% and 1.7% respectively. This comes after nine months of sharp increases.

The sharp blows to the Tel Aviv Stock Exchange have damaged the public's feeling of wealth, including the middle class. People think more than twice now before spending, even going out to eat. Car prices fell by 1.6% in October, and hotel rates fell 5%.

And what has caused the dramatic turnabout in inflation?

First of all energy, food and commodity prices. All rose sharply in the first eight months of the year, then changed direction quickly and dropped steeply.

All the signs point to continued drops in inflation on coming months, and forecasts are for inflation to fall to about 1% over the next 12 months, the lower end of the cabinet and Bank of Israel's annual inflation target.

The Bank of Israel is now changing its way of thinking, from worrying about inflation to worrying about a recession, growth and employment. That is why Fischer is lowering interest rates to help the treasury.