fischer - Bloomberg - February 22 2011
Stanley Fischer. Photo by Bloomberg
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Accelerating inflation and economic growth did the trick: While interest rates in the developed world have remained at rock bottom, the Bank of Israel yesterday jacked up its key lending rate for March.

Higher interest on the shekel is an appreciatory factor: It could attract speculators who would cause the Israeli currency to strengthen, to the misery of exporters. But analysts had been confident to a man that the central bank had no choice but to raise its rates, given the surge in market inflation expectations - to about 3.5% in a year's time and 3.25% in two years.

Though the rate hike had been expected from wall to wall, not all reactions were muted: Raising interest rates will "badly hurt mortgage borrowers" and create "unnecessary panic," charged Eyal Leibovich and Yossi Shmueli, co-CEOs of TIM, a consultancy to home buyers. They also accused the Bank of Israel of "ruining people's dreams" of buying a home.

Overdraft rates to rise at week's end

At the other end of the spectrum was Yossi Freiman, CEO of the Prico forex trading firm, who said the rate hike was the least the Bank of Israel could do given an anticipated outbreak of inflation and the instability in the Middle East, which has been causing oil prices to spiral up.

Stanley Fischer, the governor of the Bank of Israel, elected to raise the central bank's overnight rate by a quarter of a percentage point, to 2.5%. It was the second rate increase in a month, after four months during which the rate stayed at 2%. The commercial banks will be raising their interest rates on loans and credit, including overdrafts, at the week's end.

Toward the end of last week, the Central Bureau of Statistics announced that the Israeli economy had expanded by a rapid 7.8% in the fourth quarter of 2010, in annualized terms, causing jaws to drop nationwide. Nobody had anticipated economic growth that fast.

Following the disclosure, every single economic analyst polled by news agencies predicted that the Bank of Israel would raise interest rates: Leaving them low is (broadly ) considered an economic catalyst that was evidently not necessary at this time. Ayelet Nir, the chief economist at IBI, has been saying for some time that the low level of interest rates is inappropriate to the high level of economic activity.

Most analysts correctly called the quarter-percentage-point increase, though some, such as Rafi Guzlan of Leader Capital Markets, thought the central bank might go the whole hog and raise its overnight rate to the banks by half a percentage point. Inflation expectations spiked to heights not seen for eight years, analysts pointed out.

Another reason behind the rate rise is that the real estate market refuses to cool down, despite the Bank of Israel's efforts to raise the cost of mortgages.

In its announcement, the central bank stated that its pace of rate hikes is not steady, but rather depends on the inflation environment, the pace of economic growth and monetary policy at leading central banks overseas. It stressed that its monetary policy remains expansionary.

The Israeli central bank isn't the only one raising interest rates, it should be said. The central banks of other rapidly growing economies are too. A rate rise is widely expected in Taiwan in a bid to curb inflation risks. And Sweden's Riksbank raised its monetary rate last week (to 1.5% ).

But manufacturers were unpersuaded by the argument that inflation expectations have risen to their highest level since 2003, and are running above the Bank of Israel's price stability target range (which is 1% to 3% ). Yehuda Alhadef, president of the Association of Craft & Industry, claimed the increase does not comply with the central bank's stated policy of raising its rate gradually, and is all the stranger given how poorly Israeli exports have been doing.

Yehuda Talmon, president of Lahav, an umbrella organization for small businesses, argued that increasing interest rates is misguided because Israel's economic growth isn't even: It hasn't reached small businesses and does not reflect the "true situation."