Wages in Israel are soaring: Worrying data complicates Bank of Israel's work

The Israeli economy continues to recover at a rapid pace, but policymakers are dealing with a series of opposing forces that could complicate the Bank of Israel's interest rate decisions. This is according to the weekly macro review by the investment house Leader Capital Markets, published on Sunday.

According to the review, economic activity in Israel has recovered significantly, with the main exception being the hotel industry, which is still dealing with a shortage of tourists from abroad. At the same time, the labor market is defined as "very tight," where, with the exception of the construction sector, where the shortage of workers has eased following the entry of foreign workers, the industrial, trade, and service sectors report an aggravation of the manpower shortage.

The result is clearly reflected in wages. According to Leader, business wages are rising at an annual rate of about 7%. In the hospitality and food sectors, an increase of 7.5% was recorded, in construction 6%, and in industry 5.7%. The investment house warns that it is already difficult to explain the increase through changes in the composition of workers, and that this is a real risk of increasing inflation, mainly in service prices.

At the same time, the export of high-tech services continues to expand and is approaching $6 billion per month. High-tech, which accounts for about 11% of GDP, continues to be a major engine of the economy, despite a certain reduction in the workforce in the sector following efficiency measures and the penetration of artificial intelligence technologies. The strengthening of the shekel makes things difficult for some companies, but hurts companies focused on service exports less.

Thus, the Bank of Israel is facing a dilemma. On one hand, inflation expectations for the coming year have fallen to 2.03%, the lowest level since January 2021, and the strengthening of the shekel creates pressure for monetary easing. On the other hand, the recovery of activity and the jump in wages could create inflationary pressures and justify caution in the decision to lower the interest rate.

According to the review, it is difficult to expect the interest rate in Israel to fall below the level of 3.25%. Leader also notes that the yield on 10-year Israeli government bonds is about 0.75% lower than that of equivalent bonds in the United States. The investment house currently prefers the shekel-denominated instrument for the medium term and the index-linked instrument for the short term.

In the United States, the picture is also complex. July data indicated a decrease of 23,000 employed persons, alongside downward revisions of previous months' data, but the private sector actually added 30,000 jobs. The unemployment rate fell to 4.1%, partly against the background of a decrease in the participation rate to 61.4%.

Purchasing managers' data in the United States indicate a continued acceleration in activity, but the service price component rose from 67.7 to 70.3, a figure that reinforces the fear of stubborn inflation. On the other hand, the rate of wage growth per hour of work moderated to 3.2% to 3.5%, a figure that may provide some optimism regarding price pressures.

In light of the data, the American market reduced the priced-in probability of an interest rate cut in September from 55% to 42%. Leader estimates that even on a global level, expansionary fiscal policy and huge investments in artificial intelligence infrastructure and data centers may maintain a high cost of capital and prevent a significant decline in bond yields.

Looking ahead, the continued growth in high-tech service exports and fundraising abroad may continue to support the current account and strengthen the shekel. On the other hand, the rapid rise in wages and the shortage of workers pose a significant challenge to the Bank of Israel, precisely at a time when the markets are waiting for the possibility of an interest rate cut.