JP Morgan predicts that the Bank of Israel will raise the interest rate to 1.5% by the end of 2009 and to 4% by the end of 2010. The US investment house's analysts point to Israel's inflation rate, and say that, while inflation is moderating and will likely return to within the government's 1-3% target range, the fall will be slower than in other countries. In addition, Israel's expected growth will intensify inflationary pressures.
"Headline inflation decelerated toward 3% in the second quarter from a peak of 5.5% year-on-year, but it slowed significantly less than in other countries. A relatively mild and short recession is unlikely to create significant slack to restrain demand-side inflationary pressures when the economy recovers next year," says JP Morgan. The analysts expect inflation to fluctuate around 3% in the coming quarters.
Current capital market 12-month inflation expectations stand at 2.4%. Last week, Governor of the Bank of Israel Prof. Stanley Fischer kept the interest rate for October unchanged at 0.75%, after raising it by 25 basis points in August. JP Morgan believes that there is considerable room for raising the interest rate, and levies criticism at the Bank of Israel. "We had argued for a long time that the Bank of Israel had gone too far, too fast with its monetary easing earlier this year, and would be among the first central banks to reverse it," says JP Morgan.
As for JP Morgan's investment strategy, like other foreign investment banks, it advises to sell dollars and buy shekels. It predicts that the shekel-dollar exchange rate will fall to NIS 3.60/$ by year-end, 4% below its current level, saying, "The Bank of Israel is still trying to keep the shekel weak, but its effort is slowing."
JP Morgan adds, "One of the main risks to our interest rate forecast is shekel appreciation." It believes that the Bank of Israel will try to tighten the interest rate while occasionally intervening in the foreign exchange market, despite the questionable efficacy of this policy mix. "At some point, the Bank of Israel will have to accept that competitive depreciation is not a viable policy, especially when the real effective exchange rate is more than 10% below the level from the beginning of the decade," it notes.
JP Morgan concludes, "As export growth recovers, we believe the Bank of Israel will back away from intervention and allow the shekel to appreciate.
Published by Globes [online], Israel business news - www.globes-online.com - on September 30, 2009
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