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Israel to keep hiking until real interest rate is near zero

Israel to keep hiking until real interest rate is near zero
The Central Bank of Israel in Jerusalem, Israel, on Thursday, 9 January 2020.

The Bank of Israel is likely to raise interest rates further and keep them high until inflation returns to the government’s target range of 1% to 3%, its governor signalled on Tuesday, estimating that it could take a year. 

“Interest rates are likely to be at that higher level for a while until we actually see inflation really stabilising around and inside our target range,” Amir Yaron said in an interview on Bloomberg Television’s “Balance of Power.”

“We expect inflation to come back down into the target somewhere around the summer of 2023,” he said, adding that global uncertainty could alter the timeline. 

The Israeli central bank surprised most economists by delivering a 75 basis-point rate increase earlier this month, hiking for the fourth straight meeting and taking the benchmark to a decade-high of 2%. That came as price growth has been stubbornly elevated – annual inflation topped all forecasts to reach 5.2% in July, its highest level on an annual basis since 2008. 

Yaron said the bank’s targeting a real interest rate of “somewhere around zero, or slightly above it”, indicating it still has a long way to go, with the current rate at more than negative 3% when adjusted for inflation.

By that measure, Israel’s rate buffer hasn’t been positive in over a year, though it’s still currently higher than in countries like the US and the UK.

The governor spoke just days after attending the Federal Reserve’s annual retreat in Jackson Hole, Wyoming, at which chair Jerome Powell said the US central bank was committed to raising interest rates and holding them high until it can bring inflation under control. 

“That process of raising interest rates, it’s clear that it creates pain for many, but it’s pain today to avoid a much greater pain in the future,” Yaron said. 

The Bank of Israel’s rate increase in August followed more than 40 other central banks, including the Fed, that have raised rates by 75 basis points in one go this year.

Yaron is presiding over an economy that’s now at full employment, with an upswing in consumption and investment adding to the urgency of keeping inflation in check.

By “front-loading” its rate increase now, the bank was acting to lower inflation, which acted as a tax and dragged down the economy, he said. 

“It’s imperative that we bring it back to target,” he said, adding that the Israeli economy would be able to absorb the pain associated with higher rates. “It’s very important that inflation doesn’t get entrenched,” he said.

Israel’s one-year currency swaps suggest investors see the base rate rising to around 3.1% a year from now, while economists at lenders including Bank Hapoalim predict it will be closer to 3.5%. 

The Bank of Israel’s research team forecast in July that the benchmark would reach 2.75% in the second quarter of 2023, but may need to raise its predictions at the next rate decision in October. BM

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