The rise in the consumer price index by 1.3% in the past year, combined with the strengthening of the dollar against the shekel, has led many to ask whether there has indeed been a clear rise in inflation in Israel. That is a serious question in light of the fact that in recent years, inflation has maintained a very low level, and at times, negative.
We interviewed Rebecca Algrisi, the director of the consulting and research department at Bank Hapoalim, to get the answer to this and other questions. Algrisi is following developments in that field. Analyzing this renewed trend in light of the nature, strength and performance of the Israeli economy, she and her associates believe this process will continue in the near term, but that it will keep the inflation around 1%.
“We see that the inflation has finally returned to the Bank of Israel’s target range of between 1% and 3%, which is good for the economy,” explains Algrisi. “Inflation at this level, means price stability, which means that the economy works well and has realistic price increases.”
What happens when inflation is lower than the target, like it has been in recent years?
The Bank of Israel sees this as a certain negative trend, because in deflation there is a process of falling prices that harms the economy’s growth. For example, when do people run to the gas station? When they know that prices are going to rise. But if you know prices are going to go down, what do you do? You wait instead of being hasty. This hurts economic growth. I believe that we are not heading for an inflationary eruption, but lately there have been some developments in the Israeli and global economy which certainly can encourage inflation.
This year, our shekel had depreciated nearly 5% against the dollar, compared to a 10% appreciation last year. Further development occurred in the price of oil in the world that rose from the area of $35 to around $70. You can add to all of that the global trade war, which is an inflationary process, because once you impose tariffs, you raise prices.
And yet, there are quite a lot of economies around the world that have to struggle against very powerful deflationary processes that threaten them.
That is true. These are processes that cause price declines and in our estimation, they will continue to be significant in the coming years, as well. For example, technological development is considered a deflationary factor, due to the fact that it offers many new products, services, professions or processes that are substitutes for more expensive products or processes. Another process that reduces inflation is the fact that the world is getting older, and we see it in large blocs like China, Japan, Europe and even the US, where there is also a sharp decline in the birthrate.
And how does this affect the economy?
Older people consume less, compared to a young couple who get married and start a long-lasting shopping trip – a new apartment, baby products, an extra car, higher expenses on food and education, etc. In Japan, for example, they came up with a government plan intended to make older people consume more.
And there’s also the issue of online trading, through which you can make price comparisons and buy just about anything without leaving home. Quite a few fashion chains do in fact suffer from this. It is important to note that in Israel the situation is different. In many respects, the conditions here are better. The birth rate is very positive, approaching 3%, the economy is growing nicely, private consumption is high and the unemployment rate is low.
Some ask whether the conditions for raising the interest rate, which stands at 0.1% a year for the past three or four years, are finally ripe.
There are now signs of forecasts that talk about conditions that allow the Bank of Israel to start thinking about raising the interest rate. There is a relatively high growth rate of more than 3.5%, a strong labor market, low unemployment, and inflation that is approaching the Bank of Israel’s target range. In addition, the dollar is expected to strengthen in light of the fact that the US is expected to raise interest rates twice by the end of the year.
And in Israel?
Our assessment is that what will determine whether the interest rate will rise in the coming year is the continued strengthening of the dollar and the weakening of the shekel, because all the other conditions meet the criteria. There is growth and there is [virtually] no unemployment. In general, a healthy economy must operate at a positive, realistic interest rate.
We, on the other hand, are in near-percentage-point inflation and interest at 0.1%. In realistic terms, we are at negative interest rates. In Israel, however, the technology and hi-tech industry is at a very high level, and together with the gas discoveries, they create surplus foreign currency. The Israeli economy earns around 7-8 billion dollars a year from exits alone.
And in such a changing local and global market, how do you recommend bank customers build their portfolios?
In the standard average portfolio, we recommend 25% shares – half of that in Israel and half around the world, mainly in the US. An additional 40% should be invested in good, rated corporate bonds, which currently bear the appropriate yield. And 20% of the portfolio should include government bonds, half of which are linked to the CPI and half are shekel. We recommend investing 5% in foreign currency, and the remaining 10% should be left in a state of liquidity. This is especially important if the process of raising the interest rate begins at the end of the year.
This report was written with the cooperation of Bank Hapoalim.