Bank of Israel Startles Markets With Interest Rate Hike

Bank of Israel chief Stanley Fischer surprised economists and raised the base interest rate by a quarter of a percent on Monday.

Stanley Fischer sprang a surprise on Monday: The governor of the Bank of Israel raised the base interest rate, in utter contrast to prevailing opinion among economists, who had assumed the murk of economic uncertainty would preclude a rate hike.

The governor raised the Bank of Israel's August overnight lending rate for banks by a quarter-percent to 1.75%. This means that retail banks will be raising their rates on overdrafts starting Friday.

The announcement, made yesterday evening after the closing of trade on the Tel Aviv Stock Exchange, caused a flurry in currency markets: The dollar promptly sank against the shekel, dropping 0.7% to NIS 3.82.

Stanley Fischer

In 2008 and 2009, central banks around the world slashed base interest rates to rock-bottom in order to stimulate economies as the crisis raged. Most are in no rush to reinstate monetary tightening, for fear of derailing fragile economic recovery processes. Yet Fischer wants to restore Israeli interest rates to "normal" levels, as the central bank has put it, in order to rein in domestic inflation - despite knowing that any interest rate increase could drag down growth and job creation. In its announcement yesterday, however, the central bank stressed that even after the increase, its monetary policy cannot be considered contractionary.

Analysts were mixed in their reactions to the rate increase. Amir Kahanovich of Clal Finance applauded the move, calling it "soothing."

Ori Yehudai, head of the Economics Committee at the Manufacturers Association and president of flavorings company Frutarom, was less adulatory. "Given the mounting signs that the pace of economic growth is slowing, alongside the substantial retreat in exports and intense uncertainty regarding the global economy, it would have been better for the Bank of Israel to wait before raising interest rates, like the central banks in Europe and the U.S.," Yehudai said.

Yehuda Alhadef, president of the Association of Craft & Industry, called the increase "a blow to manufacturing."

The Bank of Israel's stated aim, which it repeated last night, is to keep inflation within the range known as "price stability," which is 1% to 3% a year. One thing motivating its rate hike yesterday is that inflation expectations are roughly at the upper edge of that range.

A second is the housing market. Prices continued to climb rapidly in April. "If prices continue to rise at the current pace, they are likely to deviate from the level consistent with the basic economic conditions," the central bank wrote.

The third reason for its rate hike that the Bank of Israel cites is the state of the economy. Indicators that track the economy are mixed: Some indicate expansion but others, most notably exports, indicate a slowdown. Globally, frowns the central bank, there are "growing signs" that the pace of recovery is slowing. These are not things that argue for an interest rate increase, yet the Bank of Israel feels that Israeli economic growth will continue, as it predicted before.

The fourth reason, says the central bank, is that countries where economic growth has regained brisk rates have begun to raise their interest rates.