The Bank of Israel is planning on reversing its monetary policy and raising interest rates to 5-5.5 percent over the next year, an increase of 1-1.5 percent. The current rate is 4 percent.
Forecasts are that rates will rise starting next month, probably by 0.25 percent, in response to the surprisingly high November CPI announced last Friday.
However, the central bank's target of 5.5 percent interest is not based on the recent CPI surprise, but rather was part of the bank's analysis before the CPI was revealed. Protocols of the central bank's interest-rate discussions reveal that the bank views 5.5 percent rates as the equilibrium level for the long-term.
This figure is made up of the long-term real rate of 3 percent, reflected by the yield on long-term bonds in the market; and the 2 percent inflation target, the middle of the 1-3 percent range set by the central bank and the cabinet. Finally, another 0.5 percent is added to represent the Israeli economy's risk premium, for a total of 5.5 percent.
The Bank of Israel views interest rates of under this level to be expansionary, while higher rates would be too severe and contractionary.
In recent years, the central bank allowed such an expansionary policy, which allowed the economy to grow without increasing inflation. This was partly due to the strengthening of the shekel against the dollar.
But in recent months the bank has started to worry that the shekel is finished rising, and that foreign investment in Israel will slow, while more Israeli financial institutions invest more overseas.
Therefore, the bank had already decided to start letting rates crawl upwards slowly, a decision that was only reinforced by the November CPI.
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