Central Bank Interest Rate Stays at 1.75%

Bank of Israel interest rates will stay unchanged at 1.75% for September. Although the central bank governor, Stanley Fischer, has said he wants to return interest rates to "normal" levels, he explained in the announcement yesterday that monetary policy remains expansionary, and that the pace of future economic growth remains highly uncertain.

The research department at the Bank of Israel is predicting economic growth of 3.7% for 2010, with slowing growth in the third and fourth quarters. The main cause of concern is the intense uncertainty shrouding the pace of global growth: forecasts have been lowered of late.

The Bank of Israel's main mandate is to keep inflation in check, using monetary interest rates as its tool. Inflation 12 months forward is projected to run at 1.8%, says the Bank of Israel, which is close to the midpoint of the target range set by government: 1% to 3%. While the market's inflation expectations for 12-month inflation are higher, they remain under the ceiling of that range.

The Bank of Israel was one of the first central banks to start raising interest rates from rock bottom. Most central banks around the world had lowered interest rates as far as possible to stimulate the moribund economies as crisis shook the world. Interest rates in the United States and much of Europe remain extremely low, which is in and of itself a reason to keep Israeli interest rates unchanged.

The higher interest on the shekel is, the more attractive the shekel becomes to speculators and the higher it climbs against other currencies. That is bad for Israel's exporters, who are a driver of growth.

The price of housing in Israel, however, argues for a rate hike. The Bank of Israel says home prices climbed 22% in 12 months. The lower interest rates are, the more attractive rates on mortgages are, at least in the short run, which encourages people to buy property for investment purposes.