Current Governor of the Bank of Israel Amir Yaron has won the privilege of being the one to normalize interest rates in the Israeli economy, after the failed attempt four years ago by Nadine Baudot-Trajtenberg when she was deputy governor. Yaron managed to walk between the drops, as the Bank of Israel Monetary Committee raised the central bank’s interest rate by slightly more than expected, but not so much as to cause shocks, to 0.35%, against the background of an inflation rate in excess of the 1-3% target range.
Israel’s economic data have never looked better for carrying out such a move. In an interview with “Globes” after the interest rate announcement, Yaron explains that he is not anxious about stability in the housing market, expresses no regret over raising the variable-rate component allowed in mortgages, presents the risks to the economy as another Knesset election looks to be on the cards, and talks about the possibility of returning money to the public in the light of the low fiscal deficit figures.
After the political storm raised by the defection of MK Idit Silman to the opposition, leaving the coalition tied with it on 60 Knesset seats, it is only natural to wonder what an election will do to Israel’s credit rating. Asked whether he fears a rating downgrade in such an event, Yaron replies that in his view an election will not lead to a change in the rating, but it could certainly delay any possible upgrade.
“The most important thing is certainty, for all players, in both the private and public sectors. It is clear that the economy wants certainty and a planning horizon. When there’s uncertainty, it’s damaging,” Yaron says. “Another round of elections, if it means a delay in passing the next budget, certainly does not help day to day management and will be harmful to economic reforms and continued investments that we think the economy needs. It is harmful both in the short term and to the ability to close gaps in the long term.”
How would you sum up the performance of the government so far?
“I’m not in a position to award points. I will only say that it is clear to everyone that the budget passed, bringing with it reforms. It got processes moving, so certainly in this sense we are seeing progress and would wish to see it continue.”
The other day, there was news of very flattering budget figures. As economic adviser to the government, would you say that the low fiscal deficit should be used to return money to the public?
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“The deficit has fallen to a low level, with very high tax receipts. Among other things, this reflects the trends in the markets in the past year, consumer imports, high-tech, and real estate as well. We think that at this stage it’s very important to examine how much of this is permanent before taking steps that assume that the improvement will be long-lasting. It’s easy to cut taxes, but it’s hard to raise them again afterwards.”
Commenting on investment to raise productivity, for example in education and infrastructure, slated to be about 2.5-3% of GDP, Yaron said that not everything should be carried out immediately, but that it should be a long-term program. “I would be cautious about taking steps now before we know that there is a permanent change on the taxation front. In any event, we are in a much better opening position for making these investments than was forecast a year ago.”
Effects of energy prices and security events
In its annual report for 2021, the Bank of Israel; warned against relying on future tax revenues from high-tech and real estate. “Our assumption is that although in the coming year, and perhaps in the year after that, tax receipts will be a little higher, in 2023 the tax burden in relation to GDP will more or less return to its previous level,” Yaron explains.
You rightly mentioned the strong growth in the economy and the fall in unemployment, but less good indicators are starting to appear, such as the sharp drop in consumer confidence indexes. To what extent was this taken into account in the interest rate decision, and how much of a concern is it for the Bank of Israel?
“When we come to make a decision, we of course look at many parameters. This is one of them, and among other things it reflects the fact that we are seeing energy prices climb, and also certain security events, and all this has an effect. But when we look at the economy over the period of a year, 8.2% growth in 2021, we see that it is dynamic and adaptable, and we have closed almost all the gaps arising from the pandemic. We have inflation that is still low in comparison with other countries, but we found it appropriate to start raising the interest rate.”
One of the first questions asked when interest rates rise is how far this will affect the housing market. Will demand subside and will prices fall, and how much will it cost mortgage borrowers in their monthly repayments?
“There is no doubt that raising interest rates makes mortgages more expensive,” says Yaron, and at the same time tries to sound reassuring, “According to our calculations, the current interest rate rise will add only tens of shekels a month. Of course there is a broad range of people who have taken different kinds of mortgages.”
Looking further ahead, Yaron says that given that the economy is hot from the point of view of growth, unemployment, and inflation above target, the interest rate is meant first of all to deal with these areas. “It is not meant to deal specifically with housing,” he makes clear. “I would also mention that if you don’t raise interest rates and you let inflation continue climbing, you allow it to harm the economy and those people who have taken mortgages linked to the Consumer Price Index.”
You eased restrictions on mortgages on the basis that the interest rate would be “low for longer”. Is that a consideration in deciding the speed and amount of interest rate hikes?
“Although the limit on the variable-rate component was raised, in practice we see that on average the growth in the prime rate-based component rose by ten percentage points. Of course we are constantly looking at the repayment capability system-wide, and the system is robust. But we examine it at the level of the individual borrower as well, and mortgage conditions in Israel are very conservative, and that is in order to ensure the borrower’s ability to make repayments even if there is an interest rate rise much larger than the current one.”
Taking into account that the interest rate rise will strengthen the shekel, are you concerned at such appreciation as a result of interest-rate gaps?
“There are interest-rate gaps, and of course there are countries in which inflation is far in excess of the target, and so there are certain expectations, at least in the financial markets, that they will act less gradually. But the market is made up of many elements. On the other hand, we have shown, not with words but with $35 billion, that this is one of the monetary tools in our toolbox and when necessary we will know how to use it.”
In the press conference following the interest rate announcement, Yaron stressed that inflation in Israel was substantially low in global terms (“in the bottom 10% of the OECD countries”). Many countries will raise their rates much more steeply than is expected in Israel, and so the beginning of the cycle of interest rate rises should not in itself lead to appreciation of the shekel. Besides that, he stressed (rightly) that there are many other factors that affect the shekel.
Is the inflation problem in Israel similar to what we are seeing in the US? If not, why is it different?
“We are not just seeing imported inflation but inflation in a wide range of items. Nevertheless, there is no doubt that inflation in Israel – and this is one of the reasons that we are applying the right dosage at the right time – was and remains low in comparison with the rest of the world. We are in the bottom tenth of the OECD countries as far as the inflation rate is concerned.
“This is partly thanks to low exposure to energy prices, partly because of fixed-price gas contracts; part of it is due to wage agreements between the Histadrut and the Ministry of Finance that moderated wage pressures. We have seen in recent years that e-commerce has helped in keeping price rises small. A whole array of factors has meant that although we have gone above the upper limit of the inflation target range, the excess is smaller than in the rest of the world.”
You recently said at the bank that even if inflation exceeded the target range, you would not be in a hurry to raise interest rates.
“We are in a period of monetary contraction that began in the first half of 2021. We tapered the bond purchasing program, which ended in November 2021, we ended the loans program, and essentially what we are seeing is that, contrary to many forecasts, the economy is growing well, and according to the latest figures much more strongly. These processes happened powerfully and very rapidly, and besides inflation, the strong economy led us to make the decision we made.”
Published by Globes, Israel business news – en.globes.co.il – on April 12, 2022.
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