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Bank of Israel battle against ‘sticky’ inflation rages on

The Bank of Israel building is seen in Jerusalem REUTERS/Ronen Zvulun
The central bank cited for the decision a strong economy, a tight labour market and an increase in the inflation environment
  • Key rate lifted to 4.25%, which is highest since late 2008
  • Bank deputy governor sees inflation declining from mid-2023
  • Inflation remains above 5%
  • Foreign minister criticises rate hike 

The Bank of Israel on Monday raised its benchmark interest rate by another half a percentage point, and a senior official said more increases were likely needed to rein in inflation that remains above a five percent rate.

The central bank lifted its key rate to 4.25 percent – its highest level since late 2008 – from 3.75 percent. It was the eighth straight hike since policymakers last April first raised the rate from 0.1 percent in an aggressive front-loading process.

Israel’s inflation rate hit a 14-year high of 5.4 percent in January, above an official annual target of one to three percent but below many Western peers.

Bank of Israel deputy governor Andrew Abir said they chose a half-point move instead of a quarter-point since “it’s important to show our determination to bring down the level of inflation”.

The central bank cited for the decision a strong economy, a tight labour market and an increase in the inflation environment, along with a volatile shekel, which fell one percent on Monday to a nearly three-month low versus the dollar.

Most analysts believe the tightening cycle is close to over since officials last month said the terminal rate would be four percent or a bit above. But Abir hinted at further tightening with the pace dependent on upcoming data, even as rate hikes begin to moderate housing costs due to fewer mortgage deals.

“Monetary policy-tightening is working, but we still think we’ve got some way to go in order to bring inflation down to our target,” Abir said in an interview with Reuters, declining to predict where rates would peak.

“Inflation is quite sticky. Services inflation is quite sticky,” he said, adding that price pressures were mainly demand-driven.

Not Over

Abir expects inflation to start declining in the middle of 2023, while economists foresee inflation back in the target range later this year.

“A 50-basis-points (bps) hike and it is not over,” said Bank Leumi chief economist Gil Bufman, expecting another 25 bps move at the next meeting on April 3.

Israeli foreign minister Eli Cohen said there was no justification for the rate hike and sought a process to halt future hikes. Bank of Israel Governor Amir Yaron replied that the central bank’s independence must be respected.

Inflation has been slower to ease in part due to a weaker shekel. Abir estimated the exchange rate has a 15-20 percent influence on inflation.

The shekel’s weakness has been linked to investor jitters over a planned judicial overhaul that would increase the government’s sway in choosing judges while also setting limits to the supreme court’s ability to strike down legislation.

“Clearly the process of judicial reform is turning out to be controversial. I think it does have an impact on people’s confidence in the economy,” Abir said.

Any impact the changes might have on monetary policy in the short run would come from how they affected financial markets, he said, adding: “In the medium term the impact could come from a reduction in direct investments.”

Israel’s economy grew a faster-than-expected 6.5 percent in 2022, although growth is expected to slow to below three percent this year amid the steep rate hikes.

Nine of 15 economists in a Reuters poll had expected a 25-bps move. Six others foresaw a 50-bps hike. Five MPC members voted on Monday after one voting member resigned last month.