Israel s Inflation Rate in 2013: Reality vs. Sentiment

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1 0 Israel s Inflation Rate in 2013: Reality vs. Sentiment April 2014 Finance & Economics Division Economics Department Author: Maxim Priampolsky English Editor: Noach Hager

2 1 Overview The consumer price index in Israel increased at a rate of 1.8% during 2013, slightly below the center of the official price stability target range (1%-3%). Figure 1 illustrates that in the past few years there has been a moderation in the pace of price increases. This slowdown can be explained by a moderation in economic growth in the world and in Israel in particular, which affects domestic consumption, as well as the appreciation of the shekel, which makes imports less expensive. Figure 1: Annual Rate of Change in the CPI during the Past 10 Years 4.5% 4.0% 3.8% 3.9% 3.5% 3.3% 3.0% 2.5% 2.0% 1.5% 1.2% 2.4% 2.6% 2.2% 1.6% 1.8% 1.0% 0.5% 0.0% -0.5% -0.1% Despite the moderate "inflation environment", sentiment among some households is that they are experiencing an increase in the cost of living and at an accelerating rate. This review will attempt to explain the discrepancy between public sentiment and the official data on consumer prices. A focus will also be put on the development of prices for products and services that tend to be consumed on a regular basis, which could lead to the perception that there was a dramatic increase in the entire consumption basket that makes up the CPI. Price of food (excluding fruits and vegetables) Prices for the food component of the CPI increased by 3.4% in 2013, nearly twice the increase of the CPI. An analysis of the subcomponents of the food segment show that prices for meat, poultry and fish experienced the most significant price increases of about 6% (the price of chicken surged 16.4%), while the price of dairy products increased by 3% and the price of drinks increased by 5%. These price increases forced households to spend higher amounts at grocery stores or reduce expenditure on food.

3 2 It should be noted that a portion of the price increases can be attributed to the government, which increased VAT to 18% in June 2013 and changes in taxation on alcoholic drinks, which resulted in a spike of 16% in prices of this segment. Furthermore the government has also made input costs related to food products more expensive, like water and electricity for example. The increase in input costs resulted, at least partially, in a transfer of expense to the final price that the consumer pays for food products. Price of fruits and vegetables Fruit and vegetable prices in the CPI are calculated as a separate component of food. Similar to food produce, fruits and vegetables are a basic requirement in every household in Israel. In 2013, the prices of fruits and vegetables experienced the most drastic price increase of all components in the index. Aggregate prices for fruits and vegetables increased by approximately 12%, while the two main sub-categories, fresh vegetables and fresh fruits, increased by 12% and 27%, respectively. These sharp increases were primarily the result of extreme weather that caused a temporary supply shortage of some fruits and vegetables. Price of home maintenance Costs associated with home maintenance mostly include the electricity, water and property taxes. During 2013, the cost of home maintenance increased by approximately 4%. The majority of this increase was a result of government initiated price increases for water and electricity. In addition, some of these price increases were also affected by the increase in VAT. Price of housing The housing services section has the largest weighting in the CPI (comprising around 25% of the index), because most households spend a considerable portion of their income on housing (mortgage or rent). The housing component consists of two major sub-sections. The main section, which accounts for 80% of the housing component, is called owned dwelling s services, which is based on rental rates of renewed contracts. This section attempts to quantify the household opportunity cost of an owned residential apartment if an apartment of similar quality is rented out. This section measures the change in price of new or renewed leases in order to assess the cost of using the apartment. The second section, which accounts for 20% of the housing component, is rent. This section applies to households living in a rented apartment and measures the change in rental rates of different apartments. Factors contributing to the calculation of rent include lease rates, rental duration and other fixed parameters. It should be noted that changes in the prices of apartments sold are not included in the calculation of CPI. 1 1 The Central Bureau of Statistics releases a separate monthly report called the housing price survey, which is not included in the CPI.

4 3 In 2013 the housing services component, as measured by the CPI, increased by 2.8%, with the sub-sections of owned dwelling s services increasing by 3.1%, while the rent sub-section increased by 2%. Figure 2 illustrates that the rate of housing price increases in 2013 was the lowest that it has been in six years, which contributed significantly to the moderate inflation environment. However, this rate was still higher than the overall increase in the CPI. Despite the relatively low increase in the housing component, this component contributed more than any other factor to the increase in the CPI, with 40% of the increase in CPI being attributed to housing alone. Figure 2: Rate of growth of the housing component in the CPI 14% 12% 10% 8% 6% 4% 2% 0% Other index components It is evident that many of the products and service that the Israeli public consumes on a regular basis have increased more dramatically in price than the CPI, which increased by 1.8%. This could explain the sentiment of the Israeli consumer that feels that prices have increased more than what was published by the Central Bureau of Statistics. However, alongside the price increases of some components were price decreases in other areas which contribute to the moderate inflation rate. Some examples of frequently used index components that decreased in price during 2013 include: gasoline, which decreased by 1.9% and mobile phone services, which experienced price declines of 10% due to increased competition in the industry (the decrease in mobile phone services follows a similar 10% decline in 2012).In addition Products that are consumed less frequently also declined. For example, clothing and footwear priced decreased by 1.9% while prices for household electrical appliances decreased by 2.4%. These price declines can be partially explained by the appreciation of the shekel, which decreases the cost of imports.

5 4 Other index components that experienced price declines as a result of the strong shekel include plane tickets and pharmaceutical products. Conclusions The past year experienced a very moderate inflation environment with prices increasing by 1.8%. However, many households, especially those with medium-low income levels acknowledged price increases in goods and services that are consumed on a frequent basis. On the other hand, many components of the CPI experienced price declines, primarily as a result of the appreciation of the shekel, which lowers the cost of imported products. It is also important to note that many prices were affected in 2013 by a one-time tax increase initiated by the government to reduce the budget deficit. If not for the tax amendments, inflation would have been lower, presumably in the area of 1.5%. Looking ahead, the inflation environment in 2014 is expected to be moderate. This assumption comes on the backdrop of initial signs received from inflation data in January - February 2014, with CPI decreasing in aggregate by 0.8% (January -0.6%, February -0.2%). Some noteworthy components that experienced sharp price declines in the first two months of 2014 were the prices for food, housing and water, which were also the main contributors to inflation in If the rate of price increases in housing and food will moderate in 2014, and the shekel continues to strengthen, and no additional taxes are levied on the Israeli public, then inflation should move below the midpoint of the target price stability range, and possibly approach the lower limit of 1%. If the frequently consumed components of the index experience a moderate rate of price increases, then consumers should also feel the moderate "inflation environment" in their pockets.