Analysts see 'tough call' on interest rate

Analysts were in disagreement as to whether Fischer would raise the rate further or keep it at 5.25 percent.

Ahead of Bank of Israel Governor Stanley Fischer's interest rate decision Monday, analysts were in disagreement as to whether he would raise the rate further or keep it at 5.25 percent for a fourth month. "It's really a tough call," said Leader & Co. Chief Economist Jonathan Katz. The decision, he said Thursday, would depend primarily on what the shekel - currently stable - does and how the geopolitical situation develops until then. "If there's a feeling that the military confrontation is worsening and that growth is going to take a beating, then there's a chance that [Fischer] would not raise rates," Katz suggested, citing tourism, investment and private consumption as growth factors particularly sensitive to the conflict. The strong shekel is another element mitigating against a rate hike, he said. Noting that Ben Bernanke, chairman of the US Federal Reserve, hinted Wednesday that the dollar rate could also be kept at its current level on August 10, Katz said that if Fischer feels such a decision in the US is likely it would be another factor deterring him from raising the rate beforehand. Keeping the dollar rate as it is would signal a break from two years of steady rate hikes by the Fed. Recent decisions in the US and Israel have brought the interest rates in both countries to 5.25% since the end of June, breaking Israel's pattern of maintaining a 0.25 percentage point cushion above the dollar rate. If the Israeli interest rate is kept at 5.25% on Monday and the US rate is raised two weeks later, investors would have more reason to move their money out of Israel but this would be offset by the strong shekel. "There are enough stabilizing elements that even if the shekel weakens slightly it would not necessarily be such a bad thing," Katz added. War in the North also adds another unknown variable into predictions of how Fischer will react, Katz said, noting that - going to "another extreme" - former Fed chairman Alan Greenspan, in fact, lowered the US interest rate after the attacks of September 11, 2001. If he had to make a call, Katz said he would predict that Fischer would not raise rates in the present circumstances. IBI Chief Economist Ayelet Nir, however, predicted that Fischer would raise the interest rate by one-quarter percentage point to 5.5%, with the shekel's strength allowing him to avoid a bigger hike. With "very strong" industrial production and combined 'S' indices confirming Israel's positive economic condition on the eve of the outbreak on the Northern border, the country's output gap is continuing to narrow and inflationary forces are accumulating, Nir said. "Before the escalation, we estimated that it would be possible to leave the interest rate unchanged," based primarily on expected effects of the VAT reduction and the strong shekel. "But since then, in the US, the likelihood increased that the Fed would raise rates and, in our country, the risk premium grew, as did uncertainty. So the question arises, of whether it is worthwhile to test the effect of a negative interest gap between Israel and the US." Bernanke's signal that he may not raise rates next month only partially corrected the increased probability that he would, she explained. The June index of leading economic indicators advanced 0.7%, led by a 3.7% rise in industrial production in May, a 5.3% surge in the index's goods exports component in June, a 2% rise in services exports last month, and a 0.9% rise in commerce and services revenues in May, the Bank of Israel said Thursday. Katz noted, however, that the strong 'S' index was "history," since it reflects the state of the economy in May and June. "Now we're in a whole different ballpark," he said, but added that it raises the question of how much Fischer will base his decision on actual economic indicators as opposed to the effect of ongoing geopolitical developments. According to Nir, additional factors in favor of a rate hike by the Bank of Israel are higher-than-expected inflation in June; rising fuel prices; and what she said was a net weakening of the shekel. The consumer price index (CPI), which measures inflation, rose 0.1% in June, instead of declining by the same amount, which had been expected by economists. With the conflict in the North requiring further caution, "this is not the time to allow a negative interest gap between Israel and the US," Nir said. Her prediction was strengthened by the median forecast of nine economists surveyed by Bloomberg Thursday, according to which Fischer was expect to, in fact, carry out a 0.25-point rate hike next week. Reviving the cushion between Israeli and US interest rates would allow Fischer another month to see how the situation develops, Nir added. Though the conflict will likely hurt economic activity, reducing internal inflationary pressures, Israeli inflation is particularly sensitive to fluctuations in currency exchange rates, she explained, noting that in the past economic recession and high inflation have occurred simultaneously. In 2002, for instance, prices inflated 6.5%, despite negative economic growth, due in large part to significant devaluation of the shekel. Fischer last raised the shekel-interest rate by 0.25-percentage points to 5.25% at the end of April. That was his sixth rate hike in almost as many months, bringing the interest rate up a total of 1.5 points.