Fischer Warns: Slowdown Ahead

BoI lifts interest rates by just 0.25%, dollar dives to 12-year low

The move came as little surprise to the smart money. Analysts had been expecting the Bank of Israel to lift Israeli interest rates by 0.25% for June, and last night, Governor Stanley Fischer did not disappoint.

Even though inflation is roaring, Fischer settled for tweaking local interest rates with a hike of just 0.25%, to 3.5%. Banks will shortly be raising their prime interest rate to 5%.

Granted, he made the move to help tame inflation, but some economists had been urging the governor to hike the rate by half a percent. But Fischer explains that he expects the economy to slow in the second half of the year, because of the global slowdown.

Inflation has swung well above the Bank of Israel's target range, which is 1% to 3%. That is the range defined as "price stability". Opinions differ on how high inflation will be this year, but most analysts expect it to bound beyond the ceiling of the price-stability band. Fischer's move last night is designed to curb inflation, as the central bank explained, noting expectations that inflation will climb even higher.

For instance, as commodity prices head skywards, inflation looking back 12 months has run at 4.7%, and capital-market expectations for the 12 months to come are roughly at 3%.

Economists had thought the central bank might raise the rate for June by 0.5%, after the consumer price index shot up 1.5% in April, confounding expectations. Raising rates is the traditional cure: The more expensive credit becomes, the less the public consumes, thus stymieing rising prices. But the central bank notes that it decided against a half-percent hike because it believes the shekel will gain ground, which will restrain prices.

Jacking up interest rates is not a popular move among stock-market investors, however, since companies have to pay more on loans, and the public gets better interest on risk-free bank deposits. Nevertheless, local interest rates spent the last two months at an all-time low of 3.25%, and even now, in the long-term view, rates remains quite low.

The CEO of Clal Finance Mutual Funds, Guy Chachmi, backs Fischer's decision. "The governor is signaling his awareness of the danger of looming inflation, and taking action on it," Chachmi says. "On the other hand, his behavior indicates that he has taken into consideration that a large part of the inflation is from the importing of commodities and oil ... during a period of a weak dollar. He has decided not to increase interest rates drastically, to avoid a negative impact on the economy."

Ron Eichman, Meitav's chief economist, said yesterday that the governor is forecasting that inflation will slow by the end of the year.

"The current rate of inflation is expected to slow down," he says. "Presumably, the Bank of Israel does not believe that the first-quarter growth figures are indicative of what can be expected later this year - had they thought so, the increase would have been more definitive. The decision was for a conservative increase of 0.25%. Another crucial consideration is the wish to avoid being perceived as over-manipulating interest rates."

Meanwhile, the dollar continued to dive yesterday, weakening by 0.9% against the shekel to NIS 2.98 before rebounding. The last time the dollar sank that low had been in October 1996, about eleven and a half years ago. Toward the end of the day, however, the dollar clawed back some ground, reaching NIS 3.306.

From the start of 2008, the dollar has weakened by 14% against the shekel. The Bank of Israel did not publish its usual official exchange rate for the shekel yesterday because of Memorial Day in the United States and a bank holiday in Britain.