October 10, 2016 / 11:46 AM / 10 months ago

UPDATE 1-Bank of Israel sees wage gains finally boosting inflation

3 Min Read

(Recasts, adds details, central bank comments)

By Steven Scheer

JERUSALEM, Oct 10 (Reuters) - Israeli policymakers kept short-term interest rates unchanged last month partly on a belief that inflation could rise faster than what is currently expected by investors.

All four rate setters on the Bank of Israel's monetary policy committee (MPC) voted to keep the benchmark interest rate at 0.1 percent for a 19th consecutive month on Sept. 26, minutes of the discussions showed on Monday.

They reiterated that Israel's benign inflation environment - the country has been in deflation for two years - derives from low inflation abroad, mainly a decline in oil and other commodity prices, as well as tax reductions.

Israel's annual inflation rate stood at -0.7 percent in September, well below a government target range of 1 to 3 percent a year.

But policymakers believe inflation is on its way back to target given rising wages that are expected to "act to increase unit labor cost, and to develop into an increase in the domestic inflation rate", the minutes said, assuming that commodities prices will not fall further.

"One of the committee members noted that this process is likely to develop at a more rapid rate than the rate implied in capital market prices and in the forecasts of private entities," it added.

According to the Statistics Bureau, the average wage of Israeli workers rose to 10,021 shekels ($2,639) a month in July. compared with 9,476 shekels just two months earlier.

Prior to the rates decision, the central bank noted that based on bond yields, the inflation rate was expected to reach 0.6 percent in a year's time, while private economists projected 0.7 percent. The Bank of Israel's own economists forecast a 1 percent rate at the end of the third quarter of 2017.

Stronger-than-expected economic growth in the second quarter also kept rates on hold last month. The economy grew an annualised 4.0 percent in the April-June period, revised up from a preliminary estimate of 3.7 percent. That prompted the central bank to raise its 2016 economic growth estimate to 2.8 percent from 2.4 percent. It sees 3.1 percent growth in 2017.

In addition to strong consumer spending, exports rebounded in the second quarter. Spending, the minutes said, is being driven by labour income and not by savings or higher credit.

The monetary policy committee "agreed that the current interest rate level is in line with the low inflation environment and with domestic activity - taking into account the global situation, both in terms of economic activity and in terms of monetary developments in major economies - and that it supports the return of inflation to its target range".

$1 = 3.7970 shekels Reporting by Steven Scheer; editing by Mark Heinrich

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