Capital market sources say that foreign banks are trying to pressure the Bank of Israel to increase the pace of its interest rate hikes in the coming year. The sources believe that this is the reason for the jump in expectations for an interest rate hike ahead of the monthly interest rate decision scheduled for release tomorrow (Monday).

Capital and foreign exchange market sources are awaiting tomorrow's announcement by the Bank of Israel of the interest rate with bated breath, following three "boring" years of stability. Of no less interest than the interest rate announcement will be the revised projection by the Bank of Israel Research Department of the expected interest rate hikes in the coming year. In its most recent update in March, the Research Division predicted one interest rate hike by the end of the 2018 and one more in 2019. With the current rate at 0.1%, the Research Division projected a 0.5% rate one year on.

The market, however, expects the Bank of Israel to substantially step up the pace of its interest rate hikes. For example, contracts on the inter-bank interest rate for a year from now reflect expectations of at least three interest rate hikes up to a level of 1% in a year's time. Trading in government bonds in recent days also clearly shows a rise in yields in the direction of 1%, a trend likely to result in a higher mortgage interest rate, among other things.

"A year from now, the interest rate will be 1%"

A number of factors are behind the feeling in the markets that inflation is likely to make a comeback. First of all, the recent Consumer Price Index figures show positive inflation. The index is expected to cross the 1% line in the coming months, putting it within the Bank of Israel's 1-3% target range. To this should be added the unexpectedly steep rise in the price of oil, the surge in prices of fresh produce, and inflation expectations for the coming year, which have reached 1% for the first time.

"Karnit Flug said several months ago, 'It is enough for us for inflation expectations to enter the target range,'" says Psagot Investment House Ltd. chief economist Ori Greenfeld. "Expectations are now entering the target range, and even inflation is nearing the target. If the Bank of Israel stands by what it said in March, then as a matter of principle, they should raise the interest rate.

"Furthermore, tomorrow's announcement becomes critical because the Research Division has said every year that the interest rate is about to rise, and it has been postponed every time. If the Bank of Israel does not put off the forecast for an interest rate hike, there is a very high probability that it will really happen this time, meaning that they will really raise the interest rate in November."

The market, however, is no longer waiting for the Bank of Israel; it is racing forward. "The bigger question tomorrow is what happens next - what the future plans are," Greenfeld says. "Here I am slightly more moderate than what the banks are saying, and I've seen several headlines in the past week."

The most extreme forecast by an Israeli bank was by Israel Discount Bank (TASE: DSCT) chief economist Nurit Shamir, who predicts that the interest rate one year from now will be 1%, following three interest rate hikes. Shamir's forecast is supported by fairly steep falls in government bond prices reflecting expectations of three interest rate hikes (to 0.75%) and by prices in trading in inter-bank interest contracts, which reflect three and a half interest rate hikes in the next 12 months.

Capital market players attribute these extreme fluctuations to activity by foreign concerns - banks such as Goldman Sachs and Morgan Stanley. "The recent increases in fresh produce prices have raised inflation expectations," they say, "and the foreign banks put one and one together. They identified an opportunity to kill two birds with one stone: a short position on bonds and a long position on the shekel against the dollar. If the foreign banks succeed in influencing the interest rate through the capital market, it will of course affect the shekel exchange rate. It is no accident that the shekel has strengthened against the dollar in recent days, while government bond prices have fallen."

Published by Globes [online], Israel business news - www.globes-online.com - on July 8, 2018

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