stocks down 88.
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The Governor of the Bank of Israel, Stanley Fischer, is expected on Monday to cut interest rates by a cautious 0.25 percentage points to counter inflationary pressures and gradually move annual inflation back within the price target range of between 1 percent to 3%.
"Despite an end-of-year situation where we are bound to get to zero or negative inflation rate, the Bank of Israel will not need to make dramatic changes in its monetary policy," said Gil Bufman, chief economist at Bank Leumi. "There is a consensus in the market that the central bank will cut interest rates by 25 basis points next week to 5%, while the market is also pricing in another quarter percentage point cut at the beginning of 2007."
Bufman added that the central bank in its decision-making was not so strongly influenced by short-term shocks but was looking at the long-term or 12-month inflation rate outlook of 2%, which is in the middle price target range.
"For the first time after a long period, the central bank is set to move into new territory facing a negative interest rate gap with the US Federal Reserve," said Bufman. "Thus the central bank will be taking very cautious and moderate steps going forward. The last thing the bank wants is a debacle like happened in late 2001, when the governor [David Klein] shocked the market with a sudden interest rate cut of 2%, undercutting financial stability."
In its November announcement, the Bank of Israel said that if the economy did not worsen, the inflationary environment would allow for a further reduction in the interest rate. Speaking at the annual meeting of the Banking Association on Thursday, Fischer underlined the bank's approach of flexible inflation targeting in to achieve a gradual return to the price stability target range.
Analysts at Citigroup said they expected interest rates to fall a little more than markets currently discount.
"The central bank will cut rates twice more, by 25 basis points each time with the first move at next Monday's policy meeting, in part because any failure to bring rates lower would probably rekindle shekel strength, something which the Bank of Israel wants to avoid at present," said Jean-Francois Mercier, an analyst at Citigroup.
In October, the consumer price index dropped an unexpected 0.7% after falling 0.9% in September, raising the odds of a more dramatic interest rate cut of 0.5 percentage points by the central bank. Still, analysts agreed on a moderate cut next week of 25 basis points as the inflation drop was viewed as a correction in response to lower energy costs and changing levels of the shekel-dollar exchange rates. In the meantime, oil prices also have stabilized.
"The negative index strengthens the expectation for the need of an interest cut at the end of the month but by only 25 basis points to bring back inflation within the price target range," said Ayelet Nir, chief economist at IBI Investment House. "The drop in the CPI index was not a trend or change of direction but temporary and prices will start rising."
Nir added that the economy was in good shape, while the growth of gross domestic product for 2006 was expected to outstrip all previous forecasts.
"We expect the economy to expand by 4.8% to 5% in 2006, another factor which will increase inflation," she said.
According to a Central Bureau of Statistics estimate published this month, GDP is expected to grow by 4.5% in 2006, and on Thursday Fischer raised his growth estimate for the economy to 4.8% from 4.6% previously.
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