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With Mixed Economic Indicators, Bank of Israel Raises Rates

The interest rate increase, the Bank of Israel said, is intended to help maintain price stability. Economic growth indicators present a mixed bag.
By Nissan Ratzlav-Katz
First Publish: 7/28/2008, 10:08 PM

photo: Bank of Israel

Bank of Israel Governor Stanley Fischer announced on Monday that the interest rate for August will rise by 25 basis points, to 4 percent. The rate increase, the Bank of Israel said, is intended to help maintain price stability, "in accordance with the inflation target of 1-3 percent a year." In light of Fischer's previous warnings of an economic slowdown, which is generally made worse by an interest rate hike, the decision somewhat surprised most financial analysts. 

The Bank of Israel explains its unexpected move by saying that the indicators for growth and inflation present a mixed picture, with a tendency towards rising prices but generally continued growth. Therefore, Bank officials feel, fighting inflation now is "essential as a basis for sustainable growth." June inflation was 4.8 percent, above the Bank of Israel's announced target range. The August rate increase is the third consecutive quarter-point rise in the cost of borrowing, which will bring interest to its highest level in six months.

The interest rate hike sparked a sharp strengthening in the shekel because of the higher interest that foreign investors can earn in Israel. The dollar bought only 3.456 shekels at the end of trading Monday, compared with nearly 3.5 shekels on Friday.

The drop in the shekel-dollar rate resulting from the interest rate hike is the opposite effect that Fischer wants. He has ordered massive buying of the dollar in order to keep the shekel from strengthening even further and harming exports, which could cause layoffs at a time when economic growth already is shrinking. 

In its announcement of the rate increase, the Bank of Israel pointed to moderating economic factors, as well: "There have been reductions recently in commodity and energy prices, which will serve to moderate inflationary pressures in Israel. The assessment is that the upward trend evident hitherto in
"Israel's GDP is close to its potential; import and export data for June indicate continued expansion."
commodity prices has halted, and may even have reversed."

It was also noted, "Israel's GDP is close to its potential; import and export data for June indicate continued expansion, despite the fact that the strengthening of the shekel against the dollar since the beginning of the year is a factor tending to moderate exports and thus economic activity; and data on sales in retail chain stores show continued increases."

On the other hand, statistical support for Fischer's statements in recent days that a relatively smaller rise in the rate of manufacturing growth from March to May was a "serious signal" that economic growth is slowing came in the form of two consecutive drops in the composite state-of-the-economy index. The Bank called the May and June indicators "evidence of a slowdown in the rate of growth".

The Bank of Israel said that it would "act to achieve price stability. Subject to this, the Bank will continue to support the attainment of a range of macroeconomic objectives, in particular the encouragement of employment and growth. In addition, the Bank will continue to support the stability of the financial system." 

Tzvi Ben Gedalyahu contributed to this report.