Israeli inflation lower than forecast in May, boosting odds of rate hike pause

Consumer prices in Israel in May rose at more than half the rate than was forecast, the Central Bureau of Statistics said on Thursday, easing pressure on the Bank of Israel to hike interest rates again in July.

The consumer price index (CPI), a measure of inflation that tracks the average cost of household goods, increased by 0.2% in May, below analysts’ expectations of between 0.5% and 0.6%. The May results show annual inflation over the past 12 months at 4.6%, after hovering around 5% for more than six months. That’s after the April CPI monthly figure of 0.8% surprised to the upside and marked the highest reading since July 2022.

Bank Hapoalim chief strategist Modi Shafrir, who had expected the May CPI to increase by 0.45% said that a preliminary analysis of the components of the index show that the downward surprise derived mainly from the decline in the clothing and footwear prices, which fell 0.8% versus expectations for an increase of about 3%.

Similarly, Psagot chief economist Guy Beitor said that the food, clothing and footwear components were the main causes that contributed to the downward surprise in the index.

Israelis at a shopping center in the southern Israeli city of Ashkelon, August 8, 2022. (Flash90)

In May, price increases were seen in the cost of fresh fruit, which jumped 11%, culture and entertainment was up 1.1%, and housing rose 0.5%, according to the statistics bureau. These were offset by price declines of fresh vegetables, which fell by 2.9%, while furniture and home equipment costs were down 0.8%.

Rents on renewal of contracts rose 3.6% in May unchanged from April and rents on contracts for new tenants went up 8.6% versus 9% in April.

Over the past year, the Bank of Israel has steadily hiked its benchmark interest rate — to 4.75% in May this year from a record low of 0.1% in April 2022 — in a bid to rein in inflation. The aggressive interest rate increases have rapidly fueled the costs of mortgage and loan holders who are struggling to pay off monthly payments.

Despite the monetary tightening steps, inflation has stayed far above the government’s target range of 1% to 3%. The Bank of Israel is scheduled to announce its upcoming interest rate decision on July 10.

“If before the CPI publication, the market was pricing in a probability of 60% for an interest rate hike in July, now it is pricing in an almost zero probability,” said Shafrir.

Political uncertainty around the Israeli government’s proposed judicial overhaul has seen the shekel weakening since the start of the year. Depreciation in the local currency raises the price of imported goods such as food and gas and travel abroad and leads to higher inflation. Bank of Israel governor Amir Yaron has estimated that the shekel weakness has led to “excess” inflation of at least 1%, while indicating that if the trend continued the central bank would need to keep raising borrowing costs.

Reversing the trend, the shekel last week strengthened more than 3% against the US dollar amid investor optimism that the contentious judicial overhaul would not be advanced as planned and a compromise could be reached. The currency has appreciated more than 2% this week.

“With the US halting its interest rate hiking cycle, today’s low May CPI figure, and the recent rapid appreciation of the shekel, we can expect that this combination of factors will lead the Bank of Israel to pause with interest rate hikes in July,” said Beitor.

The US Federal Reserve on Wednesday decided to halt interest rate hikes but signaled that they could rise this year as inflation remains persistent.

Bank Leumi chief economist Gil Bufman agreed that the downward surprise in the May CPI lowers the probability that the Bank of Israel will need to increase borrowing costs next month.

“However, renewed weakening of the shekel, that is significant in terms of strength and duration, could raise the odds again for an interest rate hike,” said Bufman.