The reason behind subdued inflation

A look at the graph below shows that inflation in Israel has not witnessed growth for quite some time. To be precise, the last non-negative growth in inflation was back in August 2014, when CPI (consumer price index) inflation was flat compared to a year ago. Meanwhile, the last time inflation was in the target range of 1% to 3% was in May 2014 when it was right at the lower end of the range.

For 2016, the central bank noted that inflation was subdued as prices of goods like food, fruits and vegetables, among others, fell. Also, prices of transport and communication also declined due to the “Open Skies” program. The European-Mediterranean Sea aviation agreement, which was approved by the Israeli Cabinet in April 2013, has brought down the cost of air travel, thus depressing inflation.

Inflation forecasts

The central bank informed that the average of private forecasters’ inflation projections was 0.6% for the coming one year period. At the same time, inflation expectations derived from banks’ internal interest rates were 0.4%. Meanwhile, second and third year forward inflation expectations stood at 0.8% and 1.3% respectively.

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Though inflation stood in negative territory in December 2016, a broadly rising trend can be seen since April 2016. This, coupled with the aforementioned forecasts, is making the central bank confident that a small increase of 15 basis points can be effected in a year or so.

The January 2017 monetary policy statement stated that “Based on the makam curve, the Telbor curve and forecasters’ assessments, there is a high probability of an increase in the Bank of Israel interest rate to 0.25 percent in about a year.”

For investors in Israeli equities

Israeli equities are slightly down in the year so far. Among the MSCI country indices, the index for Israel is the worst performing among developed markets, having declined by 0.1% in YTD 2017 until January 20. The political wrangling in the Occupied West Bank has dented investor confidence.

However, the new U.S. President Donald Trump’s interest in building closer ties with Israel – a drastically different path than the Obama administration – can support equities, and ETFs like the iShares MSCI Israel Capped ETF (EIS) and the VanEck Vectors Israel ETF (ISRA). Increasing exports and domestic activity will also provide more confidence to equity investors who have kept away from the country.

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