Bank of Israel head must accept interest rate increase of only 0.5% per year

The governor must act as someone who looks ahead and believes in his own predictions: inflation will head towards a level of 2.5%-3.5% for the rest of 2022 and the beginning of 2023. 

 The Bank of Israel building is seen in Jerusalem June 16, 2020. Picture taken June 16, 2020.  (photo credit: REUTERS/RONEN ZVULUN/FILE PHOTO)
The Bank of Israel building is seen in Jerusalem June 16, 2020. Picture taken June 16, 2020.
(photo credit: REUTERS/RONEN ZVULUN/FILE PHOTO)

The Monetary Committee of the Bank of Israel announced on Monday the decision regarding the level of interest in the economy. 

On the eve of the decision, the Bank of Israel interest rate stood at 1.25% per year, while the prime interest rate (which includes 1.5%) stood at 2.75%.

Many think that the economic data from the week prior required the interest rate to jump by at least 0.75%, so that the prime rate will reach 3.5% per year. 

The relevant data are the July index which jumped by 1.1%, the growth which increased in the second quarter by 6.8% (in annual terms) and the housing prices which soared 17.8% within the last year.

Looking forward at the economy

The problem is that these intelligent analysts look at past data and don’t act as forward-looking economists. The signs show that commodity prices in the world are on a downward trend, particularly oil prices. 

 THE BANK of Israel headquarters in Jerusalem.  (credit: MARC ISRAEL SELLEM) THE BANK of Israel headquarters in Jerusalem. (credit: MARC ISRAEL SELLEM)

The war in Ukraine has stagnated so the rise in oil prices has been established and won’t rise much higher. The shekel trades against the dollar and against the basket of currencies and is close to equilibrium, so there’s no need for an unnecessary jump in the interest rate.

And what is worst of all is that an abnormal upward increase in interest rates may indicate signs of panic on the part of the monetary policy captains. 

What should the Bank of Israel do?

Just as at the beginning of 2022 criticism was leveled against Governor Prof. Amir Yaron for delaying raising the interest rate and then raising it at a lower rate than required, the criticism this time may come from the opposite direction if he now raises the interest rate at a higher rate than required.

The governor should act as someone who looks to the future and believes in his own predictions: Inflation will converge towards 2023 to a level of 2.5%-3.5% per year, so with the current increase it’s recommended that he settle for a moderate interest rate increase of 0.5% in the future and nothing beyond that.