Despite rising tension with Iran: J.P. Morgan expects interest rate cut in Israel in September
Despite geopolitical tensions, J.P. Morgan analysts forecast a Bank of Israel interest rate cut in September. The bank argues that the Israeli economy remains resilient against oil-related shocks.
The geopolitical-economic question regarding the US return to intense combat in Iran has brought with it an important macroeconomic-monetary question for the Israeli consumer: what will happen to inflation and interest rates in the coming weeks. A brief reminder: inflation is on the decline, and in June it reached 1.6% — close to the lower limit of the price stability target set by the government (1%-3%). This gap between the geopolitical noise and the economic data is the heart of the story, and explains why even in the special review on Israel published today (Friday) by J.P. Morgan, the bank's economists continue to expect an interest rate cut as early as September.
Let's start with energy — the central variable. At J.P. Morgan, they remind us that even if the tension with Iran spikes the price of oil (which reached 100 dollars), Israel is one of the most protected economies in the emerging markets from such a shock, due to energy independence in natural gas with regulated local prices, refining capacity that exceeds consumption, and the low weight (only 2.6%) of gasoline in the consumption basket of the Consumer Price Index (on which inflation measurement is based). An external oil shock simply does not translate here into inflation as it does in Europe or Asia.
And yet, the markets panicked. A month ago, they priced the Bank of Israel interest rate with confidence below 3% on a one-year horizon, while today, according to J.P. Morgan, it is above 3.3%. The scenario they are pricing in: one cut and that's it. However, at J.P. Morgan they are not buying the panic: the forecast remains a quarter-percent cut in September and a final interest rate of 3%. They even point to the indicator that will decide — the July foreign exchange intervention report. If the Bank of Israel continued to buy dollars, as the bank's model estimates, this is a strong signal that cuts are on the way.
And what about the red-hot labor market? Here comes the interesting part. Unemployment stands at 2.9% — close to a historical low. According to "Okun's Law," the long-standing empirical relationship between growth and unemployment, the expected recovery after the war should lower it to 2.5% within a year — an all-time low, which usually leads to wage increases and inflation. However, the American bank does not believe in the classic formula — and therefore not in the estimate they cited. The reason: the review emphasizes that in the Israeli labor market, the labor force participation rate is "unnaturally" low. There is an entire reserve of Israelis who are out of the game and therefore are not counted as unemployed — perhaps reservists who have not yet returned to the market, perhaps workers who have given up on searching. When growth creates new jobs, they will be filled from this reserve — and will not empty the pool of unemployed. The result: this development in the labor market, which is inherently inflationary, will not create pressure on wages this time. That is, it will happen without igniting an inflationary spiral from the labor market, and therefore there will be no reason to stop the interest rate cuts.
Two points complete the picture. The first: rent, the only exception in the soft inflation picture, is rising at an annual rate of 4.2% — while housing prices are falling by 2%. Such a gap between rent and ownership does not hold for long, and at J.P. Morgan they estimate that the convergence will come through a moderation in rent. The second: the shekel, even after the recent correction, is stronger by more than 10% in terms of the currency basket compared to last year — which will continue to put downward pressure on the prices of imported goods.
The bottom line of the review is what matters: contrary to intuition, the real risk to inflation — and therefore to the Bank of Israel's interest rate path — is not in Tehran. It is in Washington. At J.P. Morgan, they believe that a sharp change in the Fed's interest rate path, or a sustained increase in Israel's risk premium — and not the price of oil — are the forces that could disrupt the positive monetary path. As long as they do not materialize, the direction is clear: an interest rate of 3% at the end of the process, and the next stop — the decision of the Monetary Committee this coming September.
