Analysis

By Raising Interest Rates, Central Bank Makes Clear Israel's Economy Is Looking Good

More solid growth appears likely amid low joblessness and rising wages, so near-zero interest rates will become a thing of the past

Acting governor of Israel's central bank Nadine Baudot-Trajtenberg
Eyal Toueg

The moment it became clear the Bank of Israel would have a long period between governors – more than a month between Karnit Flug’s departure and Amir Yaron’s arrival on December 24 – the question was whether the bank would try to project an image of business as usual.

In its surprise move Monday, Nadine Baudot-Trajtenberg did just that. As acting governor she presided over a meeting of the monetary policy committee that raised rates 0.15 percentage point – the first rise in more than seven years and the first change at all in nearly four years.

It’s hard to find a clear reason why rates are being raised now instead of two months ago or two months from now. There have been no dramatic developments over the past month to justify the step – unemployment remains low, economic growth has weakened a bit and inflation is completely under control.

But two bits of data convinced the monetary committee to act.

One is the increase in inflation in the middle of 2018 to inside the government’s annual target of between 1% and 3%. The rate has been below the target for several years.

The other is rising U.S. interest rates, which have weakened the shekel and saved the Bank of Israel the trouble of intervening in the market to prevent the Israeli currency from strengthening too much.

When economic-growth prospects are unclear, central bankers don’t raise rates. The fact that the Bank of Israel did so signals that it believes the economy’s outlook is bright. That’s based on strong data for the labor market – low joblessness and rising wages – pointing to continued strong demand.

Israelis are in a good situation. Not only is pay rising, but the spike in housing prices has leveled off and there don’t seem to be any clouds on the horizon at the moment. Under the circumstances, it makes sense for monetary policy to be “normalized.”

The base rate of 0.1% the Bank of Israel has preserved since 2015 was a historical low and not normal at all. It created an environment of cheap money and could have produced an asset bubble. Indeed, the soaring home prices of the past decade were in no small part due to low mortgage rates,

No one predicted that in September 2008, when the global financial crisis was gathering steam, all the world’s central banks would lower their rates to near zero and rates would stay there for years.

The U.S. Federal Reserve signaled three years ago that it was returning to normalcy by starting to raise rates to 2.125% today. In Japan and the eurozone, central bank rates are still negative, which is abnormal to say these least.

The Bank of Israel’s next rate decision in January will be taken under Yaron. He’ll have to decide whether to continue Flug’s policies and keep the base rate stable for some time or follow Baudot-Trajtenberg’s policies and preserve the rate differential between Israel and the United States.