Bank of Israel is ready to act if shekel ruins inflation outlook

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Israel’s central bank said a weaker shekel is putting pressure on inflation, with its governor signaling it’s prepared to act should the currency throw off the outlook for consumer prices.

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“If we see it really deviating to the point where it is really, really stressing out of bounds the pressure on our forecasts for inflation, we have the tools to also deal with that within our arsenal,” Amir Yaron said in an interview with Bloomberg Television on Tuesday.

The shekel, which is closely correlated with the performance of US equities, lost nearly 12 percent last year against the dollar in its worst performance since 1998. The currency’s swoon fed into inflation by raising the cost of imports.

Israel has raised interest rates to their highest level since 2008 and indicated they’ll remain elevated for some time. The latest decision on Monday prolonged Israel’s longest unbroken series of rate increases in decades, even as the central bank started to raise borrowing costs in smaller increments from November.

A stronger shekel was long a key factor in holding back consumer prices, prompting the central bank to intervene to hold down the currency. But the outlook shifted sharply last year, with inflation now stuck well above the government’s one percent to three percent target range.

“We will still see inflation on an annual basis going up in the next two months but then afterward modestly declining and then even more so declining in the second half of 2023 into the target rate,” Yaron said. “We are determined to bring inflation down back into its target.”

The Bank of Israel hasn’t waded into the foreign-exchange market for months, after buying more than $30 billion in foreign currency in 2021 to try to weaken the currency.

“The shekel has been very volatile throughout the year, even just in the last quarter,” Yaron said.

Stoked by faster gains in the cost of housing, apartment maintenance and food, Israel’s annual inflation reached 5.3 percent in November, the highest level since 2008.

Yaron said price growth is on track for a deceleration soon, despite risks ranging from further supply-chain disruptions abroad to looser fiscal policy at home.

Turning point?

“If we’re looking at the six-month inflation, we are seeing some elements of moderation,” he said. “This is why we believe that after February, toward the end of the first quarter, we will see inflation in Israel starting to progressively go down.”

The governor, who serves as an economic adviser to the government, has also called for fiscal restraint and warned of some of the dangers facing the economy as Benjamin Netanyahu’s new cabinet prepares to take office.

Yaron said the extent of Israel’s monetary tightening is “painful for many of the citizens who have taken mortgages.” But he said “it is a step that must be done in order to prevent further pain down in the future.”

Although Israel is set for a slowdown this year, Yaron said a recession isn’t likely. The central bank’s research team issued updated forecasts on Monday that revised down its outlook for the economy. Gross domestic product will expand 2.8 percent in 2023, from 6.3 percent last year.

That’s “a major slowdown,” Yaron said. “But it is not a recession.”

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