Bank of Israel Surprises With Rate Rise Before Transition

(Bloomberg) -- The Bank of Israel raised its benchmark interest rate to 0.25 percent on Monday, an unexpected move that brought nearly four years of record-low borrowing costs to a close.

In tightening policy for the first time since May 2011, the central bank determined that inflation is stabilizing within the government’s target range and that the economy was strong enough to handle the change.

The bank, in a statement accompanying the rate decision, assessed that borrowing costs would rise in a “gradual and cautious” manner. The shekel gained as much as 0.8 percent against the dollar, extending its daily advance and recouping some of its loss since the last rate announcement on Oct. 8.

Monday’s decision, presided over by acting Governor Nadine Baudot-Trajtenberg shifted the landscape for incoming Governor Amir Yaron, who is due to take over on Dec. 24.

“We were close to taking this decision last time, but only now did we think we were ready and the economy was ripe for this change,” Baudot-Trajtenberg said in a call with reporters. Economic growth is continuing at a “handsome pace” and inflation has become entrenched at the low end of the 1 to 3 percent target band, she said.

Bank of Israel Surprises With Rate Rise Before Transition

The Bank of Israel had resisted following the Federal Reserve after it started raising rates, instead trying to stimulate inflation after years of stagnant or falling prices. One of the few economists who did predict the hike, Jonathan Katz of Leader Capital Markets, said he expects the central bank to raise rates again once next year, in the second quarter.

“A lot will pin on the global economy and the U.S. economy, but there seems to be signs of slowing growth and less expectations that the Fed will hike aggressively, so I think Israel will follow suit,” Katz said. “I think they’ll be very cautious going forward.”

Three of 18 economists surveyed by Bloomberg forecast the bank’s decision. The central bank’s research department had expected the rate to rise early next year.

Under the recently departed Governor Karnit Flug, the bank had held borrowing costs at 0.1 percent since March 2015, waiting for inflation -- which entered the target range in June -- to stay there. The consumer price index rose 1.2 percent on-year in October, and forecasters surveyed by the bank expected 1.1 percent inflation over the following 12 months.

A sharp appreciation in the local currency is the biggest risk to the inflationary outlook, the central bank said in its statement.

Growing Appetite

Appetite for higher borrowing costs had been growing at the bank, with two out of six monetary committee members voting to raise them at their last meeting in October.

“Going forward, I think there are all kinds of questions that now arise, is this the beginning of a normalization,” said Gil Bufman, chief economist at Bank Leumi Le-Israel. “It might stir up the forecast for interest rates going ahead.”

Yaron, a finance professor at the Wharton School who will preside over his first rate decision on Jan. 7, inherits this tighter monetary policy after two quarters of weak economic growth. Israeli output grew a disappointing 2.3 percent in the third quarter, but the Bank of Israel said the economy is “converging to its potential growth rate,” despite the slowdown.

Current indicators support the assessment that the economy is at full employment, it said.

“I never see them so focused on the labor market," said Yonie Fanning, chief economist at ILS Brokers. “It’s not the same monetary policy committee that we’ve seen up until now.”

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