Rate hike is just first installment

Avi Temkin

If there are no major changes, the 2.5% interest rate will be a distant memory when 2012 begins.

The decision by Governor of the Bank of Israel Prof. Stanley Fischer to raise the annual interest rate to 2.5% can be described as "the first half of the interest rate hike." Indeed, it is a rise that heralds that a further rise is on the way.

Fischer was surprised, like everybody else in the economy, by the growth data published last week by the Central Bureau of Statistics. Those figures depicted a worrying picture of a rise in domestic demand and a fall in the pace of export growth. The moment the data was published it was clear that the interest rate had to rise.

It is fair to assume that in situation of great political certainty, and under different conditions in the foreign exchange market, Fischer would not have chosen the gradual approach and would have already raised the interest rate by 50 basis points on Monday evening. Although the world is looking an uncertain place, given the events in the Middle East, the shekel is again strengthening over the past few days , so Fischer is taking the gradual route - half the rise now and the second half later.

So what will determine the future pace of interest rate hikes after it reaches 2.75%? If in the second half of 2011, the rise in domestic demand continues, and thus pressure on prices and salaries, the Bank of Israel will raise interest above the 3% threshold by the end of 2011.

In everything relating to foreign currency, the central bank's freedom of action will probably increase in the coming months. US growth is becoming more powerful, and the monetary expansion of the Federal Reserve is coming to an end. In Europe too they are starting to talk about raising interest rates soon. The uncertainty over the entire Middle East will also influence the flow of capital into Israel in the short term, which should weaken the appreciation of the shekel.

These factors will enable the Bank of Israel to be more determined in its actions in setting monetary policy.

And if real estate prices show signs of falling, or if the rate of increase slows, the Bank of Israel can adopt a more flexible approach in monetary policy. The question is when the critical point will be reached where purchasing homes "for investment" will no longer be worthwhile and the real estate market will see a correction. For the time being the real interest rate is still negative so that the incentive to thwart speculative purchases is still not large enough. If nothing changes in this area, interest rate of 2.5% will be but a distant memory when 2012 begins.

Published by Globes, Israel business news - www.globes-online.com - on February 22, 2011

© Copyright of Globes Publisher Itonut (1983) Ltd. 2011

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