Bank of Israel on the verge of change: what awaits interest rates and inflation

Economists at the Psagot investment house conducted a weekly economic review addressing the Consumer Price Index, inflation rates, oil prices, and the Bank of Israel's interest rate policy.

"The Consumer Price Index for July rose by 0.3% (Psagot: 0.2%, consensus: 0.3%) and inflation fell to 1.5%. The core index rose by 0.5%, with core inflation remaining at 1.5%.

We continue to assume that oil prices will fall to about 70 dollars per barrel later this year following understandings between the USA and Iran regarding the Strait of Hormuz. While inflation slowed across all items, the downward trend appears to have exhausted itself, with most risks now tilted to the upside.

According to current forecasts, the Consumer Price Index is expected to rise by 2.3% over the next 12 months, assuming no changes in exchange rates or oil prices beyond those mentioned.

Key influences on the index included 'flights' (+7.5%) and 'accommodation, vacation and trips in the country' (+4.1%), pushing the 'transport and communication' item to a 1.3% monthly increase. The 'housing' item rose by 0.7% due to a rise in owner-occupied housing services.

The 'rent' item rose by 0.3%. For contract renewals, the annual rate of change rose by 0.1% to 2.6%, while for new tenants, the rate fell from 6.8% to 4.7%.

The 'food' item remained unchanged. 'Fresh vegetables and fruits' fell by 3.5%, leading to a 2.5% decrease in the 'fruits and vegetables' category. The August index is expected to rise by 1.0%, with inflation reaching 1.9%.

In August, 'food' is expected to remain unchanged, while 'fruits and vegetables' should rise by 1.5% due to seasonality. 'Housing' is projected to rise by 0.8%, 'housing maintenance' by 0.4%, and 'education and culture' by 0.9%. Conversely, 'furniture and household equipment' and 'clothing and footwear' are expected to fall by 0.2% and 1.5% respectively.

The 'transport and communication' item is expected to rise by 3.6% in August due to fuel costs and a seasonal 8.3% rise in 'flights abroad'. The September index is expected to fall by 0.3%, but due to edge effects, inflation is projected to rise to 2.2%.

Analysis and forecast: The downward trend in inflation has been exhausted. Starting with the August index, inflation is expected to rise and hover around the center of the Bank of Israel's target. Core inflation is also expected to show a slow upward trend in the coming year.

Inflationary pressures are accumulating, with risks including rental market pressures, a tight labor market, wage growth, potential shekel weakening, and the fiscal environment.

Factors for potential inflation decline include lower oil prices, a stronger shekel, or a significant reduction in reserve forces—though the latter is unlikely given the extensive security zone held by the IDF. Another factor is the impact of real estate stagnation on rental prices. We estimate the Bank of Israel will maintain a slow pace of interest rate cuts, completing two more before evaluating further steps.