22.Jul .2022 21:00

Why is inflation in Israel much lower than US and Europe?

Why is inflation in Israel much lower than US and Europe?
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In Israel the rate of inflation in the 12 months to the end of June 2022 was 4.4%, the highest rate since 2008, according to the Central Bureau of Statistics, but still significantly lower than in most developed countries. Annual inflation in Israel is currently less than half the 9.1% in the US and 9.4% in the UK.

The startling rise of inflation worldwide in the first half of 2022 is attributed to the sharp rise in energy and commodity prices since the start of the Russia-Ukraine war and the supply chain disruptions caused by repeated closedowns in China to tackle the Covid pandemic.

Although inflation is still above the Bank of Israel's annual target range of 1%-3%, why is it nevertheless so much lower than other OECD countries? In recent times, the level of inflation here has always been similar to that of North America and Western Europe, Israel's biggest trading partners, except in the few years following the sub-prime financial crisis in 2008.

Research by the Bank of Israel found that the level of inflation in Israel began to diverge from the higher path it was taking in the US and Europe in the second quarter of 2021, when natural gas prices began rising on world markets. The Bank of Israel found that the energy component in the Consumer Price Index (CPI) rose in Israel more moderately, partly because it only comprises a very small part of the CPI and partly because the price of Israel's natural gas is fixed in long-term contracts with the partners in its own offshore gas fields.

In this context, when winter comes, with the price of natural gas in Europe likely to rise due to the uncertainty of supply from Russia, while Israel's natural gas price remains fixed, the inflation gap between Israel and Europe is likely to widen further.

Research since the 1990s has shown that there is a very close connection between the rate of inflation in all Western countries and that this connection has strengthened over the past decade. The explanation for this is that most developed countries adopt similar inflation targets and they are all dependent on the same supply chains and global production.

But despite this general strong connection in the price indices of these countries, the Bank of Israel found that the connection between the rate of inflation in different developed countries is much looser when the energy component of price rises is deducted, leaving core inflation. While there is no precise definition of core inflation, the Bank of Israel defines it as inflation, minus energy, food and fresh fruit and vegetables.

According to the Bank of Israel, inflation tends to deviate over time from the path of its trade partners and because of this, it is likely that the current rapid rise in inflation in the US and Europe, and more moderately in Israel, "reflects mainly similar local developments and not necessarily a causal influence between inflation rates."

The Bank of Israel examined the connection between inflation in various countries between 2003 and 2019 and found that the rise in the percentage of inflation in the US and Euro bloc was in accordance with some rises in the level of prices in Israel. The Bank of Israel also found that the influence was fully expressed within a relatively fast period of three months but that the correlation dissipates when supervising energy prices or when comparing core inflation.

The bottom line is that the Bank of Israel concludes that the strongest link between diverging inflation in Israel and its trade partners is mainly due to fluctuations in energy prices, Globes reports.