The Governor moves ahead again

Most analysts thought that the Bank of Israel would leave its interest rate unchanged in December at 0.75%, for the 4th consecutive month, but central bank Governor Stanley Fischer surprised with a 0.25% increase – to 1%. Following the decision, analysts' reactions varied from one end of the spectrum to the other – from a statement that the interest increase constituted a serious blow to the business sector, which has just begun to recover from the recession, to the opinion that recent signs of initial recovery justified the increase in interest, which still remains low and far below equilibrium.

In its press statement on the interest rate increase, the Bank of Israel gave three main reasons for the decision:
A concern about accelerating inflation: over the last 12 months, inflation was 2.9%, very close to the upper bound of the 1-3% annual inflation target, and the bank considers that in the months ahead, inflation could pass this upper bound (this is strange because most forecasts point to restrained inflation over the next 6 months). Thus higher interest is needed to maintain inflation within the target range.
Economic activity is beginning to revive: GDP in the 3rd quarter grew at an annualized rate of 2.2% and was the second consecutive quarter with positive growth (see the blog of 22.11.09 entitled "Everbody's growing"). This and other recent signs of revival show that interest can be increased without fear of compromising the revival. In any case, a 1% interest rate is still very low and can assist activity to continue expanding.
Signs of interest increases in other countries: though some central banks have increased interest in recent months, the US Federal Reserve and the European Central Bank still have not. However, the Bank of Israel claims that these central banks are making preparations to begin increasing their interest rates during 2010, for the same reasons that interest has already been raised in Israel.

There is no doubt that Governor Fischer received "backing" for his decision from the accelerated growth of exports in recent months, proof of an initial global revival, and from devaluation of the shekel of some 3% against the US$ over the past month: he obviously considers that the higher interest rate will not strengthen the shekel enough to alter the positive export trend.

Will the recent interest hike lead to further increases in the near future? This is unlikely, even though most analysts consider current interest to be too low. The Governor will certainly wait and see what happens with interest policy in the US and Europe: at the moment, the consensus is that the Fed will not begin to increase interest before the 2nd half of 2010.

After the recent increase, interest in Israel is now 0.75 percentage points above interest in the US. The Governor will not want this gap to widen much further.

Posted on the I-Biz blog on 22 November 2009