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Further interest rate hikes may be required this year to counteract accumulating inflationary pressures due to predicted continued economic growth, increasing interest rates worldwide, and rising oil prices, Bank of Israel Governor Stanley Fischer said Tuesday.
"Continued growth of [gross domestic] product and demand in 2006, expressed in further reduction of the output gap, is expected to bring about additional raising of the interest rate in Israel," Fischer said. "Though [capital market and professional] inflation expectations for the next 12 months indicate a return to the middle of the target range. These are derived from expectations that further raises will be required to the interest rate in the course of 2006."
The capital market expects inflation at 1.7% in 2006, while professional analysts predict on average 2% (ranging from 1.3% to 2.5%), while the latest survey of companies indicated that prices would rise 2.6%, the central bank said.
Bank of Israel monetary policy aims for a price stability target defined as 1%-3% inflation yearly.
Though inflation expectations for 2006 had risen above 3% in late 2005 and the beginning of the year, Fischer successfully brought expectations back into the price stability target range, for the time being, when he hiked the interest rate another quarter percent to 4.75% in late January, a source at the Bank of Israel said.
In the event of either weakening growth in the US or East Asia (dampening Israel's economic growth as well), a change of world financial trends involving withdrawal of investments from emerging markets (including Israel), or geopolitical deterioration, current forecasts could be affected, Fischer acknowledged.
"Against this, the likelihood is high that long-term capital will continue entering the country on a significant scale - if growth in hi-tech continues at a high level," he said.
Fisher praised the Finance Ministry's 2005 fiscal performance - coupling a moderate increase in government expenditure with a level deficit - and said that in 2006 too fiscal discipline would contribute to the maintenance of a "comfortable financial environment."
This includes limiting the expansion of government spending to 1%, keeping a low budget deficit, and further reduction of the ratio of government debt to GDP, as well as implementing planned structural reforms in both the tax and financial systems, he said, highlighting the planned adoption of a market-maker government bond system and a Real Time Gross Settlement (RTGS) system.
Inflation rose 2.4% in 2005, of which fully 1.9% occurred in the second half of the year alone, Fischer said. Prices rose only one-half percent in the first half of last year.
He attributed the rise to the weakening of the shekel against the dollar, the rise of oil prices, and narrowing gap between the Israeli and US interest rates.
The dollar rose 6.8% against the shekel last year, due partly to global exchange-rate trends and capital flows to emerging markets, but also to domestic factors, Fischer noted. Forces serving to weaken the shekel included the narrowing interest rate gap and the equalization of tax rates on domestic investment, as well as investments made by Israelis abroad, which encouraged the export of capital.
Factors strengthening the shekel included privatizations, the attractiveness of investment in Israeli high-tech, and a current account surplus in the balance of payments.