Bank of Israel leaves interest rate at 5.25%

A strengthening shekel prompted the Bank of Israel to leave its key interest rate unchanged at 5.25 percent for the month of June after six hikes from a record low of 3.5% that began in September. "It was the right decision to keep interest rates unchanged," said Shlomo Maoz, chief economist at Excellence Nessuah. "An increase in the interest rate would have led to more appreciation of the shekel and harmed the economy." According to the Bank of Israel, throughout April and in the first half of May, the shekel appreciated sharply by 5% against the dollar and by 2.8% against the currency basket. Maoz added that the recent appreciation of the shekel against the basket of currencies had led to a slowdown in exports, while discouraging investors. Furthermore the Governor of the Bank of Israel, Stanley Fischer, might have taken into consideration that raising interest rates would encourage more spending by consumers on imported products as the shekel extends its gains, Maoz noted. Additional factors playing into the central's decision to keep the interest rate unchanged, according to Maoz, were the January to April budgetary surplus of about 1.7% or NIS 7 billion and the increased tax collection levels as the government has not yet passed the 2006 budget spending plan. Jonathan Katz, analyst at Leader Capital Markets, agreed that the strengthening of the shekel gave Fischer a breathing month after six consecutive hikes since September. "The decision to leave the interest rate unchanged is consistent with the achievement of price stability within the limits of the target of between 1% and 3% inflation a year as determined by the government," said the Bank of Israel in its statement. "The CPI in the past 12 months increased by 3.8%, above the upper limit of the inflation target. However in the coming months, 12-month inflation is expected to converge to within." Looking ahead, however, analysts and economists disagreed on the room for increasing interest rates over the next few months. "What is clear is that Fischer is still in a cycle of monetary tightening, meaning that rates will continue to go up through 2006," said Katz, who added that strong overall economic growth and falling unemployment make lifting rates to up to 6% "reasonable" by the year's end. Maoz, however, maintained that the key interest rate must not be raised over the next months as unemployment was still high and inflation expectation was low at about 1.6% on a 12-month basis. "Inflationary expectations, even looking three years ahead, are for 2.5% annually, which is below the government's target," Maoz said. Yet, according to Katz, an expected rate hike by the US Federal Reserve by up to 50 basis points as the year develops and an overheated economy will put pressure on prices, while pushing up inflation rates much higher than expected. "Justifying interest rate hikes over the next months, Fischer will be taking into account higher budgetary spending anticipated by an increase of the minimum wage and public sector wages," Katz said.