The Bank of Israel increased shekel interest rates on Monday
by two percentage points, to 9.1 percent. Since the beginning
of the month, the interest has been raised by 4.5 percent. On
Tuesday, in response, the dollar fell to NIS 4.92 to the
dollar and the Tel Aviv stock exchange rose, as expected.
In the days preceding the move, both the Tel Aviv stock
exchange and the bond market fell sharply, as the dollar rose
against the shekel despite its weakness in world markets. The
move is an attempt to halt the weakening of the shekel and to
lower inflation expectations, which are double the
government's 2-3 percent inflation target for 2002.
As a sign of the dollar's global weakness, the shekel fell
0.5 percent to a new low against the euro, with the 12-nation
currency fixed at NIS 4.837. Foreign currency analysts had
warned that a smaller rate hike could have caused the shekel
to weaken further.
The Tel Aviv Stock Exchange reacted positively to the rate
increase, with the benchmark TA-25 index gaining 0.33 percent
to 349.25 on Monday, before the much sharper rises by Tuesday
midday.
In a detailed statement, Bank of Israel Governor David Klein
cited initial signs of financial instability as one of the
main reasons for increasing interest rates. In addition he
pointed to worsening in fiscal discipline by the government
and deteriorating security situation with the
Palestinians.
He said the measure was needed to bring back "price
stability" to the Israeli economy, meaning inflation of 1-3
percent, and blamed the government for allowing the deficit
to swell. Klein further claimed that decreasing government
deficits would contribute to price stability.
Analysts said that the move is obviously not good for the
economy, especially as there is no fiscal restraint. However
there was little choice but to use monetary policy since
there is no real action in any other area. Though the high
interest will be painful for business, it is far preferable
to a breakdown in financial systems that all parties saw as a
serious threat.
"Israel does not want to be a Latin American or third world
nation where interest rates are at 30 percent," is how one
analyst put it.
The Manufacturers Association also agreed that there was no
option but to raise interest rates. Rimon Ben-Shaul, head of
economics for the organization, laid the blame for rising
prices on the government.
Hours before publicizing July's rates, Klein met with Finance
Minister Silvan Shalom to discuss economic policies. Shalom
informed the central bank governor of the Treasury's
successful sale of NIS 450 million of unindexed Shahar
bonds.
In recent weeks Klein and Shalom have begun cooperating more
fully, which is a positive sign for the financial markets
since it holds out the hope of a coordinated program to deal
with the problems of the Israeli economy.
Many senior economic analysts say that Israel's security
situation is certainly a serious drag on its economic
development but that the biggest factor is the worldwide
economic slowdown and especially the problems in high tech.
Israeli companies have great ideas but they cannot sell them
if no one is buying anything. The telecommunications field is
especially plagued by overcapacity and thus not likely to buy
new systems for some time.
