The Bank of Israel (BOI) has decided to raise the interest rate to 0.75 percent. This marks the second time in the last month and a half that the Bank has raised rates. The hike was expected, but the amount is higher than what people thought that it would be.
The move comes as little surprise considering the ongoing financial issues that the world is going through. Inflation is up everywhere. This has been going on for a while, largely due to Covid crisis related problems in the supply chain. As western countries came out of lockdown far eastern producers were not able to match the new higher demands – this included chips needed for all manner of electronics – and when supply does not meet the demand prices rise.
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Then came the Russian invasion of Ukraine. First, grain and other foods exported by Ukraine were cut off. Then economic sanctions on Russia and Russian oligarchs caused disruptions in investments and other problems. Finally, the wets began to embargo Russian oil, while Russia itself cut off supplies of natural gas to Europe in retaliation. This caused sharp rises in the price of gasoline at the pump and in the cost of electricity.
Raising interest rates has always been the tool by which central banks try to fight inflation. But the move is usually done as a last resort because of all the new problems that it can cause. The higher rates make it more expensive to borrow money, thereby slowing growth in the economy. This also means drops in the markets such as those that have occurred since the U.S. Federal Reserve recently raised rates too as investors expect lower profits and see more of a return in bonds and so move their money from stocks to bonds.
But inflation was not the only reason the BOI cited in its decision to raise the rate.
For example, it explained that since the previous monetary policy decision, the shekel has weakened by 4.6 percent against the US dollar, by 1.4 percent against the euro, and by 3 percent in terms of the nominal effective exchange rate.
Also, economic data continue to indicate strong activity, even though first quarter GDP contracted by 1.6 percent in annual terms relative to the fourth quarter of 2021. This followed a 15.6 percent jump in the previous quarter.
The labor market remains tight and close to the full employment that characterized the economy prior to the COVID-19 pandemic. Businesses in most industries continue to indicate a shortage of workers as a constraint on their current operations.
The upward trend in home prices continued to accelerate, with prices rising by 16.3 percent in the past 12 months.
On that last matter, the higher interest rate will make mortgages more expensive and so it will be harder for Israelis to afford to buy homes. However, the drop in demand may cause lower prices, thereby offsetting the higher mortgage rates.
As for inflation in general, Israelis have been complaining about a high cost of living for years, irrespective of recent inflation. And should the crisis in Ukraine end soon then the price of oil should come down again.
The U.S. Dollar spiked in value against the Shekel after the Fed raised rates. It may go back down again after the move by the BOI.
