Citi believes that Governor of the Bank of Israel Prof. Stanley Fischer is "more likely than not" to raise the interest rate for August by 25 basis points to 1.75% at this evening's decision. Citi acknowledges that its view is a minority one, and notes that the Bank of Israel "has a finely balanced decision to make today on its policy rate".
Citi cites a Bloomberg survey of sixteen economists, which shows that only five (including Citi) expect an interest rate hike today.
Factors against an interest rate hike include the uncertainty surrounding the global environment, with the resulting possibility of a looser Fed policy than might have otherwise have been the case; and the uncertainty surrounding Israel's economic outlook. Citi notes that the last two Israel Purchasing Management Indexes have been below 50%, meaning economic contraction, and growth forecasts for 2010 are being revised downward.
Citi says that most of the shock to Israel's GDP appears to be external, as trade deficits have widened recently.
Citi cites two arguments in favor of a rate hike today: the Bank of Israel’s commitment consistency and Consumer Price Index (CPI) expectations. Since January 2010, the Bank of Israel has repeatedly committed itself to a ‘gradual process of returning interest to a "normal" level’. While this does not require tightening at any specific moment, it does mean that the interest rate decision "should have a tendency to look beyond recent data releases towards some measure of longer-term equilibrium." Citi says that the same factor has driven the central banks of Taiwan, Korea, Thailand, Malaysia, and Canada to raise interest rates, despite evidence of a slowdown.
"Since the Bank of Israel's last rate hike was four months ago, the demand of consistency should point towards another hike today - and this would still leave the policy rate negative in real terms," says Citi.
The second main argument in favor of a hike is inflation expectations, which have risen in recent months in spite of weaker economic activity. This probably has something to do with the shekel, leaving the Bank of Israel with the worry that if the shekel stays weak, inflation expectations might deteriorate further unless the Bank acts sooner rather than later.
Published by Globes [online], Israel business news - www.globes-online.com - on July 26, 2010
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