Fischer Reacts to Inflation With Rate Hike

Israeli interest rates for July will rise by 0.25% to 3.75%, the Bank of Israel announced/

Israeli interest rates for July will rise by 0.25% to 3.75%, the Bank of Israel announced Monday night. The rate hike had been exactly as expected across the board. "The rate hike was designed to show that the Bank of Israel is doing something to fight inflation and restore confidence in the bank," said Eyal Klein, the chief strategist at Tel Aviv-based investments firm I.B.I.

Meanwhile, however, the retail banks are raising the interest they charge on credit by more than the central bank rate hikes, evidently to compensate themselves for an anticipated (and involuntary) cut in fees. Discount Bank widened its spreads yesterday, a month after banks Mizrahi and Hapoalim. Discount's maximal margins widen to 0.6% to 1.35% for corporate clients (depending on the fee type), and 1.55% for private clients.

Governor Stanley Fischer had also raised the rate for June by 0.25%. This second rate hike in a month was intended to drive home a message that he takes the rising pace of inflation seriously, analysts said. Klein added that Fischer might have taken a more extreme step of a half-point rate hike, but for the governor's theory that commodity prices will stop rising. Not that it's happened yet.

The increase widens the interest rate gap between Israel and the United States to 1.75%. Tomorrow the U.S. Federal Reserve Board will be convening, and is widely expected to leave American interest rates unchanged for the next month and a half.

"Under the circumstances the governor had no choice," said Chambers of Commerce President Uriel Lynn. But he called on the central bank and treasury to make a joint effort to lower interest rates: the Bank of Israel doesn't have the power to do it alone, Lynn said.

Its rate hike was implemented to maintain price stability, the Bank of Israel said. Its inflation target range, set by the government, is 1% to 3%, but the consensus is that inflation has bounded above the ceiling of that range. Opinions differ as to when it might converge back to the price stability target range.

Naturally, the Bank of Israel isn't the only central bank contending with fierce inflation. Bank of England Governor Mervyn King recently had to explain why inflation in the UK had spiraled beyond the range defined as stable prices.

Essentially the Bank of Israel had to choose which force to counter. One is the strength of the shekel, which is bad for exports and would argue for an interest rate cut. The other is rising inflation, which according to economic theory argues for a rate hike. Based on the high consumer price index figures for the last few months and predictions that the June index will also run high, the Bank of Israel elected to tackle prices, not the shekel.

Avivit Mannet-Kalil, Oppenheimer's manager in Israel, predicts that Fischer's work isn't done yet. She expects more rate hikes, based on the governor's signals regarding uncertainty in Israel and abroad, and statements that it's a process. "Recently inflationary pressures on the demand side in Israel have been identified, not only on the supply side," said Mannet-Kalil, meaning that inflation is not just caused by costly oil and commodity prices, but Israeli consumption, too. "I think the governor has a serious problem. On the one hand he has to prevent recession and the problem of Israeli exports, but on the other hand he has to tackle inflationary trends."