Rate hike sparks shekel, brings criticism

On Monday, Bank of Israel Governor Stanley Fischer raised the country's benchmark interest rate for August by one-quarter point to 3.75%.

July 25, 2007 07:38
2 minute read.

Reaction to the Bank of Israel's surprise decision to boost interest rates came swiftly Tuesday, with the shekel spiking and many market followers charging that the move would damage the economy. "This is a very bad decision regarding the domestic economic situation," Dr. Roby Nathanson, director of the Macro-Center for Political Economics, told The Jerusalem Post. "For global market companies, this decision won't have much of an impact, but for small, local businesses in different sectors - including services, construction, etc. - they will be affected by the higher interest rates and I don't think [Bank of Israel Governor Stanley] Fischer took this into account." On Monday, Fischer raised the country's benchmark interest rate for August by one-quarter point to 3.75 percent, saying continued economic growth and the expectation that it would continue, together with the further contraction in the output gap, signaled a tendency toward higher inflation. The economy grew at an annual rate of 6.3% in the first quarter and the central bank expects it will probably expand 5.1% this year. Since October, Fischer had lowered the benchmark rate by 2 percentage points to 3.5%, in an effort to weaken the shekel and guide inflation up to the government's 1% to 3% target range. "There is no necessity to increase the rates - inflation wasn't high, there is no devaluation, the shekel is performing at a fine level and, therefore, I see no economic reason to do this. I didn't see in the data any reason to do this and no evidence to confirm the fear held by Fischer of growing inflation rates," Nathanson said. Others, such as Morgan Stanley's Serhan Cevik, however, have expressed fears about inflation in recent weeks. "The latest gauges show no sign of a slowdown in domestic demand, thanks to improvements in the labor market, the wealth effect created by rising asset prices and, of course, cheap financing," Cevik wrote in a July 17 note to clients. "All the indicators - domestic as well as global - call for monetary tightening." The shekel strengthened further to 4.19 Tuesday afternoon after jumping to 4.2043 to the dollar Monday night shortly after the interest rate decision was announced, after trading as low as 4.2500 earlier Monday. The shekel had reached a nine-and-a-half-year high of 3.9320 against the dollar in May. "The Bank of Israel should have left the interest rate at the level where it was and not raised it," said Ohad Marani, chairman of the Manufacturers Association of Israel's economics committee, who called the decision "hasty." "Raising the interest rate will damage the competitive capabilities of exporters and the continuation of the economic expansion," he said. Exporters are damaged by a strong currency because it makes the price of their goods more expensive to purchasers outside the country. Matthew Krieger contributed to this report.

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