Blow to Mortgage Borrowers in Israel: Bank of Israel Poised to Shake the Economy

Ofer Klein, Head of Economics and Research at Harel Insurance and Finance, conducted a weekly review focusing on the interest rate decision in the US, interest rates in Europe and the Eurozone, inflation data in the UK, and the labor market in Australia.

"Touched 100. Summer has just arrived and the central banks are already hot: the escalation of tensions and the blocking of the Strait of Hormuz pushed the price of oil briefly back above $100 a barrel last week, leaving the inflationary risk center stage. The attacks on energy infrastructure in Russia demonstrated that the pressure is not coming only from the Gulf. Even if a significant part of the rise in oil prices has moderated in recent days, the sharp volatility highlights how much growth, inflation, and interest rate forecasts are now dependent on geopolitical developments that are difficult to predict.

Thus, the sequence of interest rate decisions this summer has become much more complex. Last week, the Eurozone central bank left the interest rate unchanged but clarified that the impact of the energy shock has not yet been exhausted and signaled that another interest rate hike is around the corner. Tomorrow, the Fed must make its interest rate decision. The decline in inflation in June allows it to wait, but the return of oil to the upside increases the risk that the easing in inflation was temporary. In addition, markets and forecasters are still struggling to understand the new chairman and his different approach to communication and forward guidance. Therefore, markets are pricing in a not-low probability of a surprise. In our assessment, the Fed will wait and will not raise the interest rate yet.

Regarding Israel, recent developments make the possibility of an interest rate cut at the upcoming decision in early September even more unlikely. In our assessment, the Bank of Israel is expected to exercise extra caution, as is already reflected in market expectations. Following the rise in energy and shipping prices in the last month and due to the expected rise in gasoline prices at the beginning of August, we have updated our inflation forecast for August upward to 0.9% and the forecast for the next 12 months to 1.9%.

US interest rate decision: we expect it to remain unchanged, but markets are giving a non-negligible probability that the Fed will surprise and raise the interest rate: besides the continued publication of financial reports, the focus of the week will be the Fed's interest rate decision on Wednesday. We, like all forecasters (about 70 forecasters in a Bloomberg survey), expect the interest rate to remain unchanged at 3.5%-3.75%, also against the backdrop of the weak core inflation figure in June.

However, the balance of risks in the decision is clearly tilted upward in light of the jump in oil, the decline in weekly unemployment claims, and the fact that inflation is still above the target. The main source of uncertainty is the new chairman, Kevin Warsh, who has avoided forward guidance almost entirely and has not yet clarified how he interprets the weak inflation figure against the rise in energy prices and the desire to demonstrate determination in returning inflation toward 2%.

We believe the interest rate will remain unchanged, but it is likely that the vote will not be unanimous (unlike the previous decision, which was unanimous). This will highlight the internal disputes in the bank that have intensified since he took office and against the backdrop of his desire to make significant changes to the decision-making process.

Later in the week, on Thursday, growth data for the second quarter will be published, with expectations for positive growth of about 2% (annualized) led by continued investments in artificial intelligence and private consumption. On the same day, personal consumption expenditure indices for June will also be published, which are expected to point to a moderation, similar to that recorded in the Consumer Price Index, with the focus on the core index.

Interest rates in the Eurozone remained unchanged. The improvement in economic activity at the beginning of the summer and high energy prices strengthen expectations that we will see an interest rate hike in September: the Eurozone central bank left the interest rate unchanged as expected at 2.25% after raising it in the previous decision.

However, the chairwoman noted that some council members considered raising the interest rate now, emphasized that risks to inflation are tilted upward, and that the impact of the energy shock is still ahead of us. On the other hand, she noted that inflation data at this stage do not indicate significant pass-through to service prices and wages, and therefore the bank chose to wait.

If energy prices remain high and economic activity in the Eurozone maintains (relative) stability, another interest rate hike in September will materialize with high probability, in parallel with the publication of the bank's updated forecasts. This is not necessarily because the data will require a hike, but as part of risk management as noted by senior bank officials. In our assessment, against the backdrop of the slowdown in European growth, an interest rate hike is not necessary and may even further burden growth.

Recent data from the Eurozone were relatively encouraging. The preliminary Purchasing Managers' Index for July indicated a clear recovery in economic activity at the beginning of the current quarter, after zero growth was likely recorded in the previous quarter. The index rose to 51.9 points, with a return to expansion in the service sectors alongside faster expansion in the industrial sector, mainly thanks to continued improvement in activity in Germany. However, most companies were surveyed in the middle of the month, even before the renewed jump in energy prices, so it is possible that we will see a downward revision in next month's data.

Although markets are already almost fully pricing in an interest rate hike in September, the decision will be made according to the data that will be published by then. Therefore, the focus this week will be on the preliminary inflation data for July, which will be published on Friday.

On Thursday - in our assessment, in the UK the interest rate will remain unchanged, but the decision will not be unanimous: inflation in the UK surprised again to the downside when it fell to 2.6%, the lowest pace in nearly a year. The main part of the monthly decline stemmed from cheaper fuel, food, and clothing prices, although service inflation also moderated slightly. Despite the encouraging figure, it is known that energy prices have returned to rising, so it is likely that we will see a rise in general inflation as early as next month.

The labor market shows signs of stabilization, although it still remains weak in historical terms, with the unemployment rate remaining at 4.9% in May and the decline in the number of employed persons being more moderate than expected (but still negative). The pace of wage growth also continued to moderate and reached its lowest level since 2020. The overall picture points to relatively weak demand for workers and a moderation in wage pressures.

The new Prime Minister took office last week and surprisingly chose the former Defense Minister (who resigned after calling for an increase in the defense budget) for the position of Finance Minister. At the same time, he announced a temporary cancellation of part of the VAT on electricity for households starting in October this year. These steps do not signal to the markets full commitment to meeting fiscal rules, but at this stage, it seems that investors are still granting the government a grace period, at least until the budget presentation expected in October or November.

Against the backdrop of moderating inflation and the decline in the pace of wage growth, in our assessment, the Bank of England will leave the interest rate unchanged again at 3.75% this Thursday. However, this time too, several members of the committee are expected to support an interest rate hike in light of the jump in energy prices. We believe that the interest rate will remain unchanged for the rest of the year and that the probability implied in the markets for more than 2 interest rate hikes is exaggerated.

It seems that expectations in the markets are also influenced to a large extent by the fear of fiscal risk. If toward the end of the year the Prime Minister and the Finance Minister present a more expansionary budget than expected and energy prices remain high, the central bank may consider changing the interest rate. But in our base scenario, the weakness in the labor market and the difficulty of price pressures to expand beyond the direct impact of energy support continued waiting.

Meanwhile in the Far East. In Japan, inflation is below the target but bubbling under the surface. In Australia, the labor market is tight and inflation is expected to continue to rise; another interest rate hike is a matter of time.

In our assessment, the Bank of Japan will leave the interest rate unchanged on Friday at 1.0% after raising it in the previous decision. However, the weakening of the local currency, the rise in fuel and electricity prices, strong export data, and expansionary fiscal policy are expected to continue to support price pressures and another interest rate hike.

In our assessment, the interest rate hike cycle has not yet ended, but the bank will refrain from tightening too quickly so as not to burden the bond market excessively. Therefore, the central question in the upcoming decision is whether the governor will signal that the next hike may come before the end of the year.

Labor market data in Australia for June were strong with faster-than-expected growth in the number of jobs, while the unemployment rate remained stable at 4.4%. The figure strengthens the assessments that another interest rate hike in Australia is only a matter of time, with the timing depending mainly on inflation data.

Therefore, the focus will be on the quarterly inflation data that will be published tomorrow (Wednesday), with expectations for continued growth to nearly 5% following the jump in energy prices. The focus will be on core inflation, and if it is higher than expected, the probability of an interest rate hike in the upcoming decision in about two weeks will increase significantly."