The war in Lebanon may cause inflation to accelerate as it cuts production in the North and deters foreign investment, potentially undermining the shekel, the central bank said.
"If the inflow of capital into the economy - which led to an appreciation of the shekel and hence a moderating force on prices - does contract, then the factors pushing prices up will be stronger than before," the minutes of the Monetary Policy Committee's meeting on July 24 said.
The bank raised its benchmark interest rate by a quarter- point to 5.5 percent at the July meeting, citing the risk of a weaker shekel. Inflation may accelerate even before any decline in the currency as the drop in production due to the war is expected to be more immediate than the decline in private sector demand, according to the minutes released Monday.
The outbreak of hostilities on July 12 has forced about 15% of Israel's 7 million people into bomb shelters or to move south to escape rocket attacks from the Hizbullah in Lebanon. It has also disrupted production at factories across the north of the country.
"The long-term possible damage of the fighting on private sector demand will create a moderating force on price rises," the minutes said. "However, in the short-term, the effect will be to raise prices given the more immediate impact on supply."
The conflict has not deterred foreign investment to date. Since fighting started, Hewlett-Packard Co., the world's second-biggest personal-computer maker, has agreed to buy Israel's Mercury Interactive Corp. for about $4.5 billion, while SanDisk Corp., the world's largest maker of memory cards in consumer electronics, agreed to buy M-Systems Flash Disk Pioneers Ltd.
The shekel has appreciated 1.3% since interest rates were raised on July 24.
Some members of the Monetary Policy Committee argued in favor of leaving interest rates unchanged at the July 24 meeting, saying rates were high enough to maintain price stability and that any reduction to investment would be moderate, according to the minutes. The impact on demand of the war would also help ease pressure on prices, they said.
Central bank Governor Stanley Fischer argued that higher rates would "increase the chances of a rapid recovery from the estimated damage to economic activity as a result of the fighting," the minutes said. (Bloomberg)