The end of the era of negative inflation

Tonight at 18:30, the Consumer Price Index for January 2021 will be published. This is an economic figure that usually does not open the news edition, but this economic figure is one of the most important economic data, if not the most important, certainly in the eyes of central banks and sophisticated capital market investors.

In the heated economic discourse about trendy stocks soaring by hundreds of percent a day, the economic base of financial markets and inflation, as well as inflation expectations, which are the pillars of this economic base, are sometimes forgotten.

The price index for January 2021 is expected to be negative and fall by 0.2% – 0.4% both for seasonal reasons and due to spot price declines, such as lower electricity prices. I will note that when examining the inflation environment one should not draw hasty conclusions from a single negative or positive price index but it is important to be on the pulse and try and understand where the wind of inflation is blowing.

Last year, the consumer price index in Israel fell by 0.7%, while in 2016-2019 inflation cumulatively amounted to only 1.6%, so there is no doubt that at least looking at the rear view of the inflation car, then in recent years the inflation environment in the economy is very low.

Analysts’ average forecast is that in 2021, too, inflation in the economy will be low and will be in the range of 0.5% – 0.9%. If the forecast comes true, it will be another year of very low inflation, which will strengthen the thesis for many that inflation in Israel is dead, but it is a dangerous thesis that must be examined in the morning news and not fall in love with.

In Israel, the price indices of spring and summer are traditionally relatively high, while the exit from the quarantine may sharply support demand and bring with it higher-than-expected inflation. Rising oil prices, rising commodity prices and shipping prices support some increase in the inflation environment in the near future. The Bank of Israel’s increased intervention in the foreign exchange market reduces the potential for appreciation and also supports positive inflation.

The accelerated development of e-commerce, along with reforms in the Israeli economy in various areas such as aviation, communications, etc. along with a strong and strengthening shekel year after year along with other factors, explain the stagnation in prices in the economy, but the economic treatment of Corona worldwide and Israel And the central banks are flowing huge amounts of money at zero interest rates, which, at least according to the economic text, should lead to an increase in inflation expectations and subsequently to an increase in actual inflation.

The sharp rise in inflation will not happen overnight, but no one will send us a WhatsApp message to tell us that the economic reality of a stagnation in prices has changed, so it is right to recognize the threat and its significance for our lives. A rise in inflation expectations may create pressure on central banks to raise interest rates and such a move when it occurs will have far-reaching effects on the pricing of all financial and real assets.

In 2020, the Corona managed to stop the speeding train of rental prices after many young people lost their livelihoods and returned to live with their parents. Rental prices in Israel rose year after year at an annual rate of about 2% and contributed to inflation of about half a percent each year. Last year, rents rose by only 0.1%, so inflation, which was already low, fell sharply into negative territory, but it can be assumed that the recovery of the economy in the scenario of accelerated growth in the corona will lead to a resumption of rents in recent years.

Contrary to the basic intuition of most people, the central banks, including the Bank of Israel, want inflation in the economy to be positive and are afraid of negative multi-year inflation, as this is likely to lead to a halt in investment in the economy.

In contrast to dealing with incurable diseases, then the fears of inflation can be dealt with through the purchase of index-linked bonds of the Government of Israel and / or corporate bonds.

No one knows when and whether inflation will raise its head, but anyone who fears that inflation will raise its head in the coming years in accordance with what is written in the book can effectively defend itself against such a risk.