After surprising investors in Israel in August and hiking the interest rate by 0.75%, more steeply than expected, the Bank of Israel Monetary Committee, headed by Governor Prof. Amir Yaron, will announce its interest rate decision for October tomorrow afternoon.
The question is not if the Bank of Israel will hike the interest rate tomorrow but by how much. The more conservative estimates see the Bank of Israel hiking the rate by 0.5% but following the latest negative developments in the world economy many analysts have told "Globes" that they believe the Bank of Israel will again raise the rate by 0.75%. "It is indeed a dilemma," says Leader Capital Markets chief economist Yonatan Katz. "The August Consumer Price Index was lower than expected, so there are some signs of moderation in economic activity." Katz stresses that this is a factor that may lead to a more moderate interest rate increase by the Bank of Israel.
But Katz adds, "On the other hand, it should be remembered that in all four previous decisions, the Bank of Israel surprised and raised the interest rate upwards at the higher level of the forecasts. The Monetary Committee decisions were also unanimous, so it seems that this is a hawkish committee, which is very much influenced by the policy of the US Federal Reserve and the central banks in general."
The Bank of Israel interest rate is currently 2%, while only in February of this year it was only 0.1%. In all four of the last decisions, the Bank of Israel raised the interest rate, and the hike of 0.75% in the last decision in August was the sharpest that the Bank of Israel has made in 20 years.
Rampant inflation worldwide has led the US Fed and other central banks to raise the interest rate to try and cool rising prices. If the Bank of Israel does not raise the interest rate fast enough, the shekel could plunge even further against the dollar, and inflation in Israel would increase even more due to more expensive import costs.
There is a real dilemma
As someone who worked at the Bank of Israel in the past, I sat on the committees there and absorbed the spirit of the discussions. I estimate that the Bank of Israel is most likely to raise the interest rate by 0.75%," says Ofer Klein, Head of the Economics and Research Department at the Harel Insurance and Finance Group. "There is a real dilemma over whether to raise the interest rate by 0.5%, so that the interest rate will rise over a longer period of time, or to carry out the hikes in larger installments over a shorter period. I estimate that the Bank of Israel will go for the second option of sharp and rapid increases."
Why
"Because there really is inflation in Israel. I estimate that within a year, inflation in Israel will converge again to the Bank of Israel's targets (1% to 3%). In Israel, a large part of inflation is related to rent prices. They are almost a quarter of the increase in the index. Beyond that, the Israeli job market is tight. In other words, the unemployment rate is very low, and participation rates for the 25-64 age group is high. The unemployment rates in the economy are the lowest recorded since David Ben-Gurion was prime minister. All of this is not related to world fuel prices nor to the war in Russia. The way to deal with domestic inflation is through interest rate increases."
How high will the Bank of Israel raise the rate?
According to Prof. Asher Blas, former Bank of Israel chief economist and a lecturer at Ashkelon College, "Interest rate hikes will continue until we move into the middle of the inflation range, when annual price rises will range between 1% and 3%, preferably nearer 2%." He adds, "When expectations weaken for a sustained period, and we are not there yet, then there will be an expected change in interest rate policy."
As of August 2022, the CPI rose 4.6% over the previous 12 months, while in the US the annual inflation rate was 8% and in some European countries where the energy crisis has hit hard, annual inflation has moved just above 10%. So in Israel inflation is less than half the average Western rate.
Maybe the Bank of Israel has breathing space to wait and not even raise the interest rate this time?
Prof. Blass rules out such a scenario. In his estimation, the interest rate hikes could lead to a sharp strengthening of the dollar, which would make prices here even more expensive. According to him, "The dollar has already strengthened against all currencies in the world and against the shekel. We are already at an exchange rate of over NIS 3.5/$. If the Bank of Israel does not raise the rate, the shekel is expected to weaken even more, and then there is more chance of inflation coming via the exchange rate (imports). Along with the desire to moderate housing prices, through raising rates and other factors, it is difficult for me to see a situation where the Governor of the Bank of Israel would not fall into line and not raise the rate at all."
"All the central banks are promoting the same agenda"
The US dollar has strengthened by about 14% since the beginning of the against the shekel to over NIS 3.56/$. A rapid depreciation of the Israeli currency against the dollar due to the interest rate differential has made products imported into Israel more expensive, including food products and various raw materials including oil. Therefore, Klein estimates that although the more correct process would have been to make a gradual increase in the interest rate, the Bank of Israel has actually been compelled to choose the "fast path" of sharp increases, which could harm the economy, due to the dictates of the global economy.
"It would have been correct to raise interest rates gradually over a longer period of time," says Klein, "but all the major central banks in the world are promoting the same agenda: 'Let's strike quickly.' We have seen countries like Sweden that hike the rate by 1%, in a single decision. "Even in Canada, for example, they raised the interest rate by 1%. Even the EU, weakened by the war in Europe and energy prices, still raises the interest rate on the euro by 0.75%. The US has raised the rate on the dollar by 0.75% for the third time. In Switzerland they raised the interest rate by 0.75%. So in the end we are an open and small economy, the interest rate is not really set by the Bank of Israel, but all over the world, according to market conditions. If they raised the interest rate on the shekel every time by say 0.25%, then the currency would crash."
Published by Globes, Israel business news - en.globes.co.il - on October 2, 2022.
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