Despite inflationary pressures and the threat of a slowdown in the US economy, the Finance Ministry remains cautiously optimistic about its growth forecasts for the local economy, earmarking the financial services industry as the next engine of growth. "Despite the clouds and uncertainty about a slowdown in the US economy as a result of the suprime mortgage crisis, we are cautiously optimistic about continued growth in the local economy and for the time being our growth forecasts [of 4.2 percent in 2008] remain intact," said Yarom Ariav, director general of the Finance Ministry at the annual seminar of the ministry's capital market division in Tel Aviv on Tuesday. "At the same time, there are inflationary pressures here and abroad driven by the increase in prices, in particular commodity prices, which in turn puts pressure on interest rates. However, the state of the economy should not be judged by one month but should be put into proportion by looking at the big picture." At the beginning of the week inflation jitters hit the local stock market following Friday's unexpected 0.4% rise in the consumer price index for November, putting pressure on the Bank of Israel to raise interest rates when it releases its January rate next week. Since the beginning of the year, inflation has grown to 2.8%, just below the top of the central bank's target range of 1% to 3%. Shlomo Nehama, former chairman of Bank Hapoalim, however, rebutted the Finance Ministry's outlook with a bleak and pessimistic view of the state of the global economy. "The Israeli economy has been growing at a record pace, but I am not convinced that the positive wind will continue to blow at this pace," said Nehama. "The environment in the financial sector in Europe and the US is pessimistic. The slowdown of the US economy will have an impact on the world economy and we need to be prepared." The pains of the subprime mortgage crisis are far from over, Nehama added, saying they would continue to be felt throughout 2008 and into 2009. "We will see more uncertainty in the markets as banks continue to make huge losses, higher risk levels and higher borrowing costs and less liquidity," he predicted. Also speaking at the seminar, Finance Minister Ronnie Bar-On warned that in a reality of Israel being a player in the global economy, the country was running a race against time and, therefore, needed to upgrade and turn the local financial market into a regional financial center over the next decade. "There are many countries, who are seeking to get to the front of the stage in the financial game trying to stabilize their economies to become a magnet for foreign capital," said Bar-On. "Because we are a small player in the global world, we need to ask ourselves whether in the long-term Israel could become a regional financial center, that is, a center attracting investors in developing economies east of Germany and west of China - this is the challenge I put in front of the regulators and the Ariav committee, which will commence its work over the next few days." Bar-On added that he believes the financial industry in Israel could develop in the same way as the high-tech industry developed and as such become the next engine of growth for the economy. "The same powers that led to the miracle of the hi-tech boom can lead to an Israeli finance miracle. The power center of Israel lies in the human capital," said Bar-On. "I talk about the young and talented you can find today spread across the global financial markets and investment houses occupying key positions as advisers or partners and we need to find a way to get them come back home." Among the steps that needed to be examined to achieve the goal of turning the local financial market into a finance center, according to Bar-On, are cutting red tape and reducing bureaucracy; raising regulatory structures to international standards; improving training and developing more sophisticated financial products; merging the three regulatory bodies into one; and seeking cooperations with global financial regulators and authorities. Interest rate hikes cut industry production Increases in interest rate negatively affect industry production and cause a reduction in prices as a result of lower demand, according to a study by the Bank of Israel published on Tuesday. "A rise in the interest rate generally results in a cutback in production with a reduction in prices that reflects a demand effect. A similar tendency is evident in other countries too," the research study carried out by Dr. Sigal Ribon of the Bank's Research Department, which examined the effect of changes in the Bank's rate of interest and changes in the exchange rate on different industries, stated. The study found that the impact on demand and volume of production resulting from a rate change was felt more strongly in industries that produce durables. At the same, prices in hi-tech and highly concentrated production industries rose less in reaction to a rise in the interest rate. "It was also found that a temporary depreciation of the shekel against the dollar is reflected in a price rise in nearly all industries and a fall in production in some of them," the study noted. Furthermore, it stated, about half of the price volatility could be ascribed to fluctuations in the exchange rate, and only a minor 5 percent could be ascribed to interest rate variability. A smaller share of the fluctuations in the volume of production, about 10%, was explained by exchange rate variability, and a similar share was explained by fluctuations in the Bank of Israel's interest rate.