Morgan Stanley: Bank of Israel won’t meet inflation target

“Policies to increase employment are key to eradicating poverty.”

Morgan Stanley says, “The shekel’s further appreciation (especially as the dollar keeps weakening against other currencies) is a challenge for the central bank.” The investment bank therefore believes that it will be very difficult, if not impossible, for the Bank of Israel to bring the Consumer Price Index (CPI) back with in its 1-3% inflation target, and that deflation is probable.

Morgan Stanley predicts, “Although seasonal factors and stronger domestic demand are likely to result in inflationary readings in the coming months, the year-on-year inflation rate will remain in the deflationary territory.” The investment banknotes that the CPI rose by 0.2% in March, in line with its estimates. ‘As a result, even with the first positive inflation reading since last July, the annual inflation rate moved to -0.9%, down from -0.8% in February and -0.1% at the end of last year.”

Morgan Stanley says, “We have long argued that the shekel is fundamentally undervalued and therefore interest rate cuts may not necessarily weaken the exchange rate and bring inflation within the target range. We still think that the state of the Israeli economy justifies keeping interest rates unchanged, but the shekel’s valuation has moved even beyond our bullish assessment and thereby is likely to encourage the central bank to lower the policy rate by 25 basis point to 3.75% at the end of this month.”

In a new survey on Israel, entitled “Poverty of the Welfare State”, Morgan Stanley says, “Breaking away from the legacy of the welfare state, Israel has achieved faster growth. Although a peace deal with the Palestinians remains distant, structural reforms and prudent fiscal policies in recent years have helped rationalize Israel’s welfare system, reducing its burden on the economy… The burden of welfare spending and transfer payments declined rapidly to 36.5% of GDP, helping to lower the overall budget deficit to 0.9% of GDP at the end of last year, giving a significant boost to the economy.

“Rationalizing welfare expenditures has merely unveiled the ‘hidden’ poverty. With lower transfer payments to households, the number of people living below the relative poverty line increased from 20.6% in 2002 to 24.7% in 2005. Institutional factors and structural changes are behind the poverty problem. In our view, institutional factors are far more important for understanding the underlying trend. For example, two segments of the society - Arabs and ultra-Orthodox Jews - do not participate in the labor force and constitute 60% of the poor in Israel.”

Morgan Stanley also notes, “Globalization and the rise of Israel’s technology-intensive sectors have resulted in a dual economy, in which higher demand for skilled workers relative to the demand for less-skilled labor input leads to a wider earnings gap and thereby a worsening in relative poverty indicators … Of course, as Israel’s own experience with welfare spending has shown, transfer payments to households cannot eradicate poverty on a sustainable basis. Increasing employment, not welfare spending, will deal with poverty. International figures show that the poverty risk is predominantly a function of educational attainments, which become even more important in Israel’s high-technology economy. Indeed, the incidence of poverty increases from 11.2% among Israelis with sixteen years of formal schooling to 47.8% for those with less than eight years of schooling. This is a direct result of the level of participation in the labor market, which increases from 23.5% among Israelis with less than eight years of education to 77.3% among Israelis with at least sixteen years of schooling. Therefore, policies to increase employment, not unsustainable welfare spending, are key to eradicating poverty and improving income distribution.”

Published by Globes [online], Israel business news - www.globes.co.il - on April 16, 2007

© Copyright of Globes Publisher Itonut (1983) Ltd. 2007

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