Bottom Shekel / The Bravest Central Banker in the World

You have to give credit when it's due. Stanley Fischer, governor of the Bank of Israel, who surprised almost everyone yesterday by raising April interest rates by 0.5%, proved he is one of the bravest, most honest and consistent central bankers in the world. Maybe even the bravest.

Fischer is not the only central banker facing terrible dilemmas. He too has to balance stimulating the economy by keeping interest low, while keeping a lid on inflation and asset bubbles.

Countries with fast-growing economies have another problem: Raising interest rates may very well strengthen the local currency, hurting exports. Most central bankers use the same tactics to try to resolve these dilemmas. They speak of risks and inflation, and say they may raise rates in the future. But in reality, they surrender to political pressure. In America and Europe, the pressures derives mostly from high unemployment rates. It is hard for their central bankers to raise rates when employment is so low, even if all know financial assets are inflating and losing touch with reality because of the cheap money flowing into the system.

Elsewhere, pressure comes from exporters and manufacturers. They love low exchange rates. And there are those places where the powers that be will not so much as snap fingers at the rich and powerful.

Stanley Fischer is different. For months he's been warning that Israeli inflation is nearing intolerable heights. He sent out all the right messages, hinted time after time, and made it clear that interest rates will rise over time. Fischer also warned about housing prices, which are rising too fast, he has said. Housing prices are not only affecting inflation, they could even threaten financial stability.

How? Because lots of people took out big mortgages with floating interest rates. And if housing prices fall and interest rises, their house will be worth less and their loan repayments will be bigger.

A month and a half ago Fischer spoke out excatly about such a case, and even presented a graph showing how Israel's housing prices were similar to those of countries such as the U.S., Spain and Ireland just before their housing markets crashed.

His words went unheeded. Home prices kept rising.

In the last 12 months, home prives rose 16.3%. Inflation, partly because of rising fuel prices, passed the upper limit of the government target range of 3% and has reached 4.1%. Expectations for inflation over the next 12 months, based on the bond markets, are now 3.7%.

That is why Fischer took action, despite pressure not to. Next week, the prime rate will be about 4% and the cost of mortgages, overdrafts and credit card debt will rise.

For the first time in a long time the banks will offer significant interest on deposits, about 3%, and maybe even a little bit more. Anything to cool off the housing market and economy in general, even a little bit.

This is not the end. Fischer will wait a month or two to study how the latest interest rate hike worked. If it doesn't dampen inflation and housing prices, he will move again.

This morning, many will think Fischer's act was crazy, partly because he's one of the few central bankers willing to raise interest by half a percent at a go.

But Fischer is simply doing his job properly, uncompromisingly, ignoring political pressure.

Other central bank governors are the crazy ones. They are keeping interest rates too low and sacrificing the medium and long term for the short term.

In fact, despite yesterday's announcement, real Israeli interest rates are negative, taking inflation into account - or at the very least, they're zero.

What about exchange rates? Forex traders were surprised too yesterday, and the dollar fell almost 1% against the shekel right after Fischer's announcement. Pressure from exporters and manufacturers against Fischer will certainly start again this morning, but he has nerves of steel, buttressed by the naked economic data: The economy expanded by 7.7% in the fourth quarter of 2010. Tax revenues are high. Stock prices are near record heights. Even the shekel is holding its own as are exports, surprisingly.

Fischer, like other central bankers, has to choose the least of all evils, and he has convincing answers for the politicians, the interested parties, the rich.