The Monetary Committee of the Bank of Israel (BOI) Monday announced a decision to increase the interest rate by 0.5 percentage points to 1.25 percent. The raise had been expected for some time and follows similar moves made in other countries.
In making its decision to raise rates the BOI cited a number of different factors, with inflation at the center. It said that inflation in Israel is above the upper bound of the target range, at 4.1 percent over the past 12 months. With that, it remains significantly lower than in most advanced economies. The inflation rate is expected to be 4.5 percent in 2022, and to decline to 2.4 percent in 2023.
Also, the Israel labor market is in a full employment environment. Businesses in most industries continued to indicate a shortage of workers as a constraint on their current operations. The tight labor market is leading to some wage pressures in the business sector.
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Raising interest rates is the standard way for fighting inflation. The idea is that by tightening up the money supply people and businesses will have less available cash to spend. As such, demand will go down leading to lower prices. In the U.S., the Federal Reserve recently raised rates too in an effort to curb inflation. This was done because there, in part, the inflation was caused by large government grants to the public and businesses to help them deal with the economic crisis caused by the Covid pandemic.
But the current inflation problems do not only stem from having too much capital out there. It began with supply chain problems caused by the end of the Coronavirus shutdowns. Demand spiked quickly while manufacturers were not ready to provide the needed supply to meet this demand. As such, prices rose.
And there is also the current problem with high gasoline prices which were not caused by the inflation. This was caused by the current crisis in Ukraine. In response to the Russian invasion of that country the West imposed oil embargoes. This, added to general uncertainty caused whenever there is such a world crisis, led to oil prices spiking.
So, the question is really how raising interest rates will cause the price of oil to drop. It will only do so if the worldwide demand for gasoline drops considerably, or if the conflict in Ukraine comes to an end and the various embargos are lifted.
Another reason that the Bank of Israel raised rates is that the Shekel had depreciated in value considerably against the U.S. Dollar after America raised its rates. A weaker Shekel means that imports cost Israelis more to buy and in turn feeds local inflation.
Since the previous monetary policy decision, the Shekel weakened by 5.1 percent against the US dollar, by 2.9 percent against the euro, and by 3.6 percent in terms of the nominal effective exchange rate.
But the country was only recently lamenting that the Shekel was too strong and people worried that this was hurting foreign investments in Israel. It may be that the best case for Israel will be if the Shekel drops only a little bit and ends its slide against foreign currencies.