It will be extremely surprising if the Bank of Israel does not raise its interest rate tomorrow, for the first time since 2018. Israel’s strong economic performance, and the inflation reading above the target range for two successive months, leave the central bank with little choice.
Israel’s GDP grew 8.2% last year, and in the final quarter its growth rate was the highest in the West. The labor market has improved rapidly and is back where it was before the coronavirus pandemic, contrary to OECD forecasts that Israel’s labor market would be the last to recover. The rise in housing prices seems unstoppable, and, most importantly, Israel’s inflation rate is in excess of the target.
So far, the Bank of Israel has stuck by its view that inflation in Israeli is low in comparison with the rest of the world. This is still the case: in February, inflation in Israel was running at an annual rate of 3.5%, which compares with 7.9% in the US and 7.7% in the euro bloc. But a slowdown in price rises around the world is not on the horizon, with commodity prices climbing because of the war in Ukraine, and in Israel the inflation rate is shortly expected to exceed 4%.
The capital market is pricing in an aggressive interest rate hike of 0.5%, but it is unlikely that the Bank of Israel will take such a drastic step tomorrow, one that would harm its credibility. In an interview with “Globes” in early February, Deputy Governor of the Bank of Israel Andrew Abir said that if inflation went above the target range, the bank would not be in a rush to raise its interest rate, but since then the global economic picture has changed.
An interest rate rise will make money more expensive, increase monthly mortgage repayments, retard economic activity, and lead to a rise in unemployment, which is currently at a low of 3.2%, a rate that compares with 3.5% before the coronavirus pandemic. A tight labor market puts upward pressure on wages, and as far as the Bank of Israel is concerned it supports an interest rate rise. The question here, as in the US and the rest of the world, is whether the fight against inflation will succeed at the cost of a slowdown in economic activity.
Market analysts see the Bank of Israel raising its rate in each of its scheduled interest rate announcements this year. In the US, the Federal Reserve has already raised rates and is expected to step up the pace of interest rate hikes over the rest of the year in order to rein in inflation, which is approaching 8% annually. The US capital market, however, is pricing in an economic slowdown, which will force the Federal Reserve to moderate the pace of interest rate rises, if not actually to cut its rate. At present, the Federal Reserve is ignoring these signals from the bond market.
Unemployment in Israel keeps falling
Israel’s economy grew 8.1% in 2021
Israel’s February CPI reading higher than expected
The bottom line is that an interest rate hike by the Bank of Israel tomorrow looks inevitable. Any other announcement will be pretty surprising.
Published by Globes, Israel business news – en.globes.co.il – on April 10, 2022.
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