Flug: Inflation outlook beginning to improve.

Reuters
Jerusalem

Israel’s economy is facing increased risks, including from the recent upsurge in violence, and short-term interest rates are unlikely to rise for the foreseeable future, central bank governor Karnit Flug said in an interview.
However, with the inflation outlook beginning to improve and the labour market remaining strong, the current monetary policy mix, including interest rates at just 0.1%, seems “appropriate”, Flug said.
The Bank of Israel forecasts growth of 2.6% in 2015 but that could be in danger should a wave of Palestinian attacks on Israelis that began a month ago continue. It expects a 3.3% rate of growth next year.
“If the violence remains at the current level and ends soon then the effect will be minor and growth will be in the vicinity of 2.5%,” Flug said in an interview with Reuters.
“But if it deteriorates and is prolonged, then past experience suggests that it can have a more significant impact on private consumption and tourism. This is a risk that has emerged since our forecast was made” last month.
There are signs that consumers have curtailed shopping while some tourists have cancelled future trips to Israel. Flug noted that tourism had not fully recovered from last summer’s Gaza war. But growth was likely stronger in the third quarter than near-zero growth in the April-June period, she added.
The Bank of Israel has kept its benchmark interest rate at a record low of 0.1% for an eighth straight month and said monetary policy would remain accommodative for a “considerable time” - which Flug declined to quantify. The rate has fallen from 3.25% since 2011.
“We wanted to ... give some indication of the path of interest rates,” Flug said, citing global weakness, repeated downward revisions of global trade and clear indications major central banks could ease rates further.
“Together... some additional risks to activity gave us a more solid assessment that our policy will have to remain accommodative for a longer period of time.”
The central bank’s own economists forecast steady rates through the first quarter of 2016 and a gradual rise starting in the second quarter, after the Federal Reserve is expected to start raising US rates.
Flug, who became central bank chief in late 2013 after Stanley Fischer stepped down, played down the need for Israel to lower rates to zero or below, or the possibility of quantitative easing measures like bond buying in current circumstances.
“Unconventional measures are taken when you are in unconventional circumstances,” said Flug, who declined to elaborate on the scenarios that could trigger such steps. “We are still in an environment of moderate growth and have a reasonably strong labour market that includes a low (5.3%) unemployment rate, high number of (job) vacancies and increasing real wages. That is an element that should support a return of inflation to the target range” in the second half of 2016.
Israel has an annual inflation target of 1%-3% a year but the country has been mired in deflation for more than a year. The rate was -0.5% in September and is expected to reach +0.5% in a year.
Flug attributed the negative inflation to short-term and one-off factors such as lower oil and other commodity prices as well as declines in some taxes and utility costs.
“We see negative (inflation) numbers mostly on the tradable part of the CPI. In non-tradable we see an increase in prices of about 0.7, which is close to the lower bound of the target range,” she said.
One lingering concern for policymakers remains the shekel. At a rate of 3.87 per dollar, it is flat since the beginning of the year but stronger than a 3.94 rate a month ago.
“We see the shekel as notably over-valued,” Flug said, referring mostly to a 6% appreciation in 2015 in terms of the shekel’s nominal effective exchange rate.
Since the shekel has harmed exports - some 35% to 40% of economic activity - the central bank has been “active” in the foreign exchange market when it sees fluctuations that are not consistent with fundamental forces, she said.
Flug also said that should the global economy deteriorate further, governments will need to supplement any stimulus steps taken by central banks. She said that it was unlikely there will be a quick resumption of global growth.