Israel‘s economy is recovering quickly from the COVID crisis but interest rate increases are some way off given inflation is expected to stay well contained, Bank of Israel Governor Amir Yaron said.
Yaron said policymakers have once again begun to focus on inflation after the consumer price index turned positive in March for the first time in a year at an annual rate of 0.2%. The rate is projected to enter the official 1-3% annual target range soon and stabilize around 1.6% for the next few years, based on bond yields.
A key question, the governor said, is how much of the gain stems from bottlenecks in the economy and adjustments in supply and demand.
“We’re not seeing a risk of any eruption in inflation that is detrimental to the economy and therefore that allows us to continue to be accommodative, and I think it’s going to be very market-based in terms of where and how fast we see these processes come through the economy,” Yaron told Reuters.
“At some point, depending on economic activity and depending on inflation, depending on financial stability, etc., those will be the considerations that will enact a change in the primary focus point for a change in the [interest rates] stance.”
Israel‘s benchmark interest rate has stood at a record low of 0.1% for more than a year after a single 15-basis point cut in April 2020 at the outset of the pandemic. Despite a spike in unemployment caused by three lockdowns aimed at limiting the coronavirus’s spread, the central bank opted to hold the line on rates, preferring other measures to keep credit flowing such as buying bonds and cut-rate loans to banks.
The Israeli economy contracted a less than expected 2.6% in 2020 and Yaron said growth remained on track to hit the bank’s 6.3% estimate in 2021 “as long as there is no new mutation that is detrimental.” Israel‘s economy is almost fully open with more than half of the population fully vaccinated.
“Israel‘s economy is bouncing back very fast,” he said. But while the jobless rate has gradually dipped back to 8% from more than 25% last year, pre-virus levels of around 4% may be tough to attain since some jobs have been eliminated given companies have become more efficient as a result of the pandemic.
Yaron has called for more training while the economy transforms but Israel‘s political situation is also in flux following four inconclusive elections in two years and a fifth election later this year is possible.
As a result of the political squabbling, Israel is still using a pro-rated version of the 2019 state budget that was approved in mid-2018. Yaron said that in the short term, the lack of a budget is not a big issue but Israel requires reforms in education, infrastructure and regulation that is harming the private sector.
He said Israel needs investments of 2% of economic output for several years, particularly in education where Israel scores poorly among OECD peers, that will boost Israel‘s economy over then next decade.
“Time is money… we are losing time in putting these reforms in place and the gaps are only being extended,” Yaron said.
Yet foreign investment in Israel remains strong and has helped to underpin the shekel. The Bank of Israel in January had said it would buy $30 billion of foreign currency in 2021 after buying $21 billion last year but the shekel is only down 1.2% versus the dollar so far this year.
Over the first four months of 2021, the bank has bought nearly $20 billion of forex. “We won’t be shy extending it if needed and depending on economic conditions and activity,” Yaron said, dismissing Israel‘s forex reserves nearing $200 billion as a big issue.
Similarly, Yaron said the bank is in no rush to decide whether to end its government bond-buying program, in which it has bought NIS 62.3 billion out of a planned NIS 85 billion. He noted that a tapering in recent months has been a “function of markets” and that guidance on its quantitative easing (QE) program would come in mid to late summer.
“We will know more where the economy is somewhere around summer,” Yaron said, adding at its current pace the QE could last another eight months. “We also need to see what is happening to [the economy and bond yields] in the rest of the world.”