(Bloomberg) -- Sign up for the New Economy Daily newsletter, follow us @economics and subscribe to our podcast.
Most Read from Bloomberg
Israel’s central bank issued tougher guidance as it raised interest rates by the most in over a decade, moving aggressively after the government’s collapse last week left officials to rely more on monetary tools to control above-target inflation.
The monetary committee increased its key rate to 1.25% from 0.75%, in line with the forecasts of all but two of the 19 economists surveyed by Bloomberg. It’s the third consecutive hike and the largest since 2011, when Stanley Fischer was the central bank’s governor.
“The Israeli economy is recording strong growth, accompanied by a tight labor market and an increase in the inflation environment,” the committee said in a statement Monday. In a slightly hawkish change of tone, it no longer referred to its cycle of rate hikes as a “gradual” process.
The Bank of Israel’s shift into a higher gear echoes what may be the most drastic global monetary policy tightening since the 1980s. It follows the US Federal Reserve’s biggest move since 1994, a decision that’s left other central banks rushing to keep up.
An interim Israeli cabinet that’s now in charge is legally constrained from taking significant measures that could help the country cope with faster price increases, possibly handcuffing fiscal policy into next year if elections result in a longer deadlock.
If Israel’s political impasse persists until next year, a more restrictive fiscal policy environment “may alleviate inflationary pressures, and thus may require a somewhat less contractionary monetary policy,” said Karnit Flug, a former Bank of Israel governor and now vice president at the Israel Democracy Institute think tank in Jerusalem.
Although the Bank of Israel has had to work alongside a caretaker government during frequent bouts of electoral instability in recent years, the difference this time is that Governor Amir Yaron is having to contend with inflation stuck since January above the government’s 1% to 3% target.
“In order to ensure future economic growth, it is important to continue to exercise fiscal responsibility during this period,” Yaron said in a speech following the rate announcement. He added that any elected government should “work to pass a budget upon taking office while advancing the necessary reforms and investments.”
Alongside the rate decision, the central bank’s research department issued revised forecasts for this year, downgrading the outlook for economic growth while raising its estimate for inflation.
Gross domestic product will expand 5% in 2022 and 3.5% next year, it said. Price growth is now seen at 4.5% this year before slowing to within the government’s target and reaching 2.4% in 2023.
To bring consumer costs under control, Yaron has pivoted from a long stretch of keeping borrowing costs near zero, raising rates by a quarter-percentage point in April and 40 basis points in May. Inflation reached an annual 4.1% in May, accelerating for a second month.
While it’s significantly lower than in many countries around the world, Israel is also coming under pressure from a surge in global food and energy costs, with the central bank recently warning that wages were beginning to rise in response to rising prices.
Currency depreciation is another concern. The shekel, which reached a 26-year high in 2021 and acted to stem inflation, has weakened against the dollar this year, adding to price pressures by making imported goods more costly. The Israeli currency strengthened after the rate decision and traded up 0.4% versus the dollar.
“The pace and the extent of policy tightening may depend more on external developments, and we think will largely be a function of exchange-rate pressures,” Goldman Sachs Group Inc. economists Tadas Gedminas and Kevin Daly said in a report.
Inflation is likely to accelerate further in the months ahead, as a global rally in commodities feeds into domestic costs. Israel has already announced significant increases to fuel and dairy prices in recent days, and is mulling a possible increase in the cost of electricity.
Markets and analysts see scope for much higher borrowing costs ahead. One-year interest rate swaps are pricing in an increase to around 2.4% a year from now.
The central bank’s research team predicts the key rate will reach 2.75% in the second quarter of next year.
Economists at Barclays Plc and Citigroup Inc. are among those predicting the monetary committee will vote to raise the base rate by half a percentage point again when it next meets in August.
(Updates with economist comment in 14th paragraph.)
Most Read from Bloomberg Businessweek
©2022 Bloomberg L.P.