Markets Fail to Follow Klein's Interest Lead

Shekel strengthens on Friday's rate, but at NIS 4.978 to the dollar, market response disappoints

Despite the exceptional 1.5 percent hike in the Bank of Israel's key lending rate on Sunday, the shekel gained only marginally against the dollar yesterday. The representative rate was set at NIS 4.978, an appreciation of 0.25 percent over Friday's representative rate, but 1.5 percent lower than its rate earlier in the day.

The failure of the shekel to gain ground against the dollar surprised most analysts and was seen as an indication that the interest rate tool is losing its influence on the market because of the crisis of confidence in the country's economic leadership.

Economic sources in Jerusalem said yesterday that the Bank of Israel could raise interest rates again at the end of June if the devaluation of the shekel continues. The central bank said yesterday that it would do everything necessary to get the economy back on track to price stability.

However the bank said that at this stage it does not intend to raise its key lending rate before the end of June. The central bank usually announces its rates on the last Monday of every month. The bank said that the market should be allowed to digest the 1.5 percent rate increment and that it would be following events on the foreign exchange markets in the coming days.

Bank of Israel Governor David Klein refrained yesterday from commenting on the interest rate hike. Finance Minister Silvan Shalom and his director general Ohad Marani, who have both criticized Klein in recent months, also refrained from commenting on the governor's latest step.

However, senior treasury officials yesterday expressed concern at developments on the foreign exchange markets. Within the corridors of the treasury, officials criticized Klein, saying that it was time for the central bank governor to "stop chattering and take action."

The treasury officials said that if the governor was so upset, then it would be better for him to step down and deal with his private affairs. They said that for the moment the treasury is not officially responding to the rate increase because of fears that a public confrontation with the central bank governor could rock the markets, leading to an exodus of funds from the country and a financial crisis.

The officials also laid into Klein for attacking the economic austerity plan after it was passed almost unchanged by the Knesset last week. "The governor's criticism was interpreted as a vote of no-confidence in the economic plan. No wonder there's a rush for the dollar," the officials said.

Bankers blame low confidence

The banking system was busy yesterday trying to work out the implications of Sunday's rate hike and its surprisingly minor effect on the shekel-dollar rate.

Bankers said that the primary causes behind the rate hike's failure to curb the dollar were the public's loss of confidence in the economic leadership and the market's anticipation of the publication of the Rabinowitz Committee's recommendations on tax reform tomorrow.

The bankers left no room for doubt with regard to the market's desire to see better communication between the finance minister and the governor of the central bank. Banking industry sources said that a dialogue and confidence-building measures between the two sides, such as a suspension of the plan to set up a central bank board of governors and the issue of Gilboa dollar-linked bonds by the government, would transmit the desired message to the market and help stabilize the forex markets without the need for a further interest rate hike.

A senior banker said that Sunday's 1.5 percent interest rate rise anticipated the market's reaction to tomorrow's scheduled publication of the Rabinowitz report on tax reforms. Several of the committee's recommendations have already been leaked to the press and the implications of the reforms are that foreign currency and foreign currency deposits will become more attractive, while shekel deposits and shares will become less so.

Israel Discount Bank's chief economist, Rami Amir, said yesterday that the market is expecting a higher interest rate rise and therefore the dollar did not drop significantly. However, he said that he did think another interest rate rise was called for. "The governor's decision to raise rates was correct and so long as the exchange rate does not continue to rise, there's no need for another hike. Of course, if the depreciation continues, another rate increase will be needed, but the question is will it work.

"The economy is in a difficult situation and the solution lies in dealing thoroughly with the budget problems, the deficit, the security situation and the lack of confidence in the economic leadership," he said.