While the fight against inflation is going on in full force worldwide, there is a significant factor that refuses to surrender to interest rate hikes. The job market, continues to be tight, with full employment in Israel and elsewhere. This creates a situation in which many employees, who are not prepared to see their salaries eroded, demand raises, which fuels inflation and could result in more Bank of Israel interest rate hikes.

What is a salary spiral?

Salary pressures are reflected in the increase in monthly wages, as shown by the data of the Central Bureau of Statistics published every month. The data, published last week, show that in June the average wage in the economy increased by 6.3%, well above the annual inflation rate, which stands at 4.2%.

This high increase in salaries can lead to pressures that will harm the Bank of Israel's fight against inflation. Moreover, a rapid increase in salaries is a supporting factor for continuing to raise interest rates. The result: salary pressures may lead to additional interest rate hikes, which cuts income for many households in the country.

"Salary pressures are an alarming trend"

Market sources believe that the latest public sector salary agreement between the Histadrut and the Ministry of Finance will contribute to inflationary pressures in Israel. However, Rafi Gozlan, Chief Economist at IBI Investment House has reservations about this assessment. "The salary agreements closed some of the gaps that opened up with the private sector, where there was a faster increase in salaries in the high-tech industry than in general," he says. Gozlan believes that the increase in public sector salaries will contribute to market demand, but most of the pressure comes from the private sector.

Yonatan Katz, chief strategist at Leader Capital Markets agrees with Gozlan, and is sure that the pressure comes mainly from the private sector rather than the public sector. He said, "Salary pressures in the economy are an alarming trend which creates an inflationary environment higher than that which the Bank of Israel wants to achieve." Katz stresses that the current monthly salary rise will fuel inflation and will not allow it to drop to the target set by the Bank of Israel of 3%.

Apart from that, he distinguishes between salary pressures in the different sectors of the economy: "At the start of the year, the sector that contributed to the increase in salaries in Israel was the public sector, when the salary agreements in the economy came into effect and public sector workers received a grant worth NIS 6,000. But this is still a one-time grant which should not have a long-term effect. The business sector is much more critical and affects inflation."

How will the situation influence interest rates?

This is not the only factor that the Bank of Israel will take into account in the next interest rate decisions. The exchange rate, for example, is an equally significant parameter. IBI's Gozlan estimates that job market data supports the hike in interest rates by the Bank of Israel, but does not think that this will be decisive regarding the decision in September. "I estimate that the effects of the tight labor market on inflation will be reflected later this year, so I expect at least one more interest rate hike before the end of the year," he said.

Not everyone agrees with this. Bank Leumi chief economist Dr. Gil Buffman says that in his view the Bank of Israel will not raise the interest rate in the coming months."

Source - Globes - Image - Shutterstock