Barclays: Israel's economy in tailspin

Barclays Capital says that the unexpected slide in inflation implies that the Israeli "economy is apparently in a tailspin". While Barclays believes that the Bank of Israel will reverse its interest rate policy, Citi Capital Markets and JPMorgan doubt that an interest rate cut is imminent, but they agree that interest rate hikes are now off the table. However, Goldman Sachs says that the Bank of Israel will raise the interest by 50 basis points by the end of the year.

Barclays also notes that the Israel Purchasing Managers Index fell to 49.4 points (below the 50-point threshold marking economic expansion from contraction), and that exports fell by 10 points, suggesting stagnation. "In addition, the 'tent demonstrations' are probably hurting growth." As for the interest rate, it says, "With this collapse in inflation, probable collapse in inflation expectations and growth slowdown, the Bank of Israel will at least switch to a neutral bias and possibly consider lowering rates in the not too distant future."

Citi says that it had expected the Bank of Israel to continue with its interest rate hike, "partly due to the fiscal consequences of Israel's social protest movement", the new data forces a change in view. It believes that the interest rate will stay unchanged at 3.25% through the end of 2011. It adds that as long as the shekel stays relatively week - it depreciated 4% against the dollar and euro in the past four weeks - the Bank of Israel will consider that enough loosening is taking place through the foreign exchange market to make a rate cut unnecessary and undesirable.

JPMorgan admits that it was surprised by the 0.3% drop in the CPI for July; it had expected the CPI to rise by 0.3%. It believes that given the likelihood that inflation will fall within the 1-3% target range sooner than previously expected, and the sharp fall in the Israel Purchasing Managers Index, increases the risk of an interest rate cut, but not this month.

JP Morgan concludes, "We expect the Bank of Israel to remain on hold at least until the second half of 2012." It expects Israel's GDP growth to slow to 3.8% in the second quarter from 6.8% in the first quarter, and predicts 4.6% growth in 2011 and 2.7% in 2012.

Goldman Sachs also says that price cuts and core inflationary trends have moderated and that "this is a clear reflection of the political pressure brought to bear on policymakers during the recent demonstrations." Even if the price cuts are a "one-off", they give the Bank of Israel breathing space to respond to the current softening in the global growth and ongoing financial market volatility. It still expect the Bank of Israel to raise the interest rate to 3.75% by the end of 2011, but cautions that a "downside GDP surprise later this week would prompt us to revise our forecasts."

Published by Globes [online], Israel business news - www.globes-online.com - on August 16, 2011