Just before Monday's vote on eliminating the reasonableness grounds on first reading, Bank of America, one of the world's largest investment banks, issued a stark warning. "We think that the most significant risk to inflation in Israel is the depreciation of the shekel, which is driven by political noise," the bank's economists wrote in a survey distributed today to the bank's customers.
"Inflation is finally cooling, but we have a long way to go – CPI inflation fell from a peak of 5.4% in January to 4.6% in May and nontradable inflation fell from 4.9% to 4.2%. We believe that the most significant risk to inflation is the weakening of the currency, and expect that the Bank of Israel is likely to stop and wait for additional data in order to assess the tightening of its policy."
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The Bank's economists continue: "Since the depreciation of the shekel stems from political noise and not from economic imbalance, we think it will be more effective to limit volatility through the foreign exchange market by interventions by the Bank of Israel in the market. However, the Bank of Israel has stated many times that their main tool is the interest rate. We still think the intervention option is on the agenda."
Bank of America also said that if political uncertainty continues "in a way that causes permanent changes in the economy that weaken the currency, then the Bank of Israel will have to continue raising interest rates."
Bank of America is relatively optimistic about the continuation of talks at the president's residence, saying, "We see a chance to restart negotiations during the Knesset recess. Our base scenario still stands on a compromise that can be found on the issue of judicial reform. However, it is difficult to predict political processes and they cause a lot of noise and volatility."
"Will be forced to raise interest rates." Bank of Israel Building, Photo: Oren Ben Hakon
"As of now, the opposition and coalition have stopped negotiations at the president's residence. Tensions rise as the government pushes to pass one of the bills in the reform package unilaterally. Protests against the bill continue, while the opposition has sought to suspend the legislation to resume talks. The Knesset's summer session ends on July 31, so in a few weeks we expect to see some form of resolution to the situation.
There will be increased pressure on the Bank of Israel to raise interest rates more." Bank of America building, photo: AFP
"If the talks in the president's residence start again, we think the risk premium currently priced in the exchange rate could calm down again. We believe that both sides have a risk in finding a compromise and the Knesset recess could be a good opportunity. The rest of the reform is expected to be presented to the Knesset in its winter session, starting October 15. If the efforts fail and the two sides do not return to talks, and unilateral legislation continues, pressure will increase on the Bank of Israel to raise the interest rate more."
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