Israel Surpasses Fed With Bigger Rate Increase Than Forecast

(Bloomberg) —

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Israel extended its longest cycle of monetary tightening in decades, surpassing an interest-rate hike by the US Federal Reserve for the first time since starting to raise borrowing costs in April.

The central bank lifted its benchmark rate on Monday to 4.25% from 3.75%. Most economists surveyed by Bloomberg expected an increase of a quarter percentage point, matching the Fed’s last move.

The monetary committee didn’t signal an end to its tightening cycle, saying only that it had “decided to continue the process of increasing the interest rate” with the eighth straight hike. The shekel traded 0.8% weaker against the dollar as of 5:18 p.m. in Tel Aviv, on track to close at the weakest since early November.

With borrowing costs already at the highest since 2008, the Bank of Israel is now having to contend with a surprise acceleration in inflation and economic growth. The upswing adds to a bout of political turbulence that helped make the shekel the worst-performing currency in the Middle East this month, after the Lebanese pound.

The Bank of Israel started to raise borrowing costs in smaller increments from November even as inflation shows little sign of easing. Governor Amir Yaron has signaled policymakers “are determined” to bring price growth back into its target range and expects a deceleration to take hold after February.

Price gains, above the official target range of 1%-3% for over a year, unexpectedly accelerated to an annual 5.4% last month.

Higher energy costs for households, alongside housing inflation, were among the biggest drivers of price increases in January.

Going Higher

“The strong growth figures and the increase in inflation along with the devaluation of the shekel contributed to the move,” said Ofer Klein, head of economics and research at Harel Insurance Investments & Financial Services.

Klein said he doesn’t rule out a rate increase to 4.5% at the central bank’s next meeting in April, “when the focus will be on the question of whether the depreciation of the shekel will continue or slow down and how the world’s central banks behave.”

Expectations in the market are for more monetary tightening ahead. Israel’s one-year currency swaps indicate investors see the base rate rising to around 4.5% a year from now.

Though expected to moderate in the months ahead, inflation is also coming under pressure from the shekel, whose strength was once a key factor in holding back consumer prices. It’s down around 3% against the dollar so far in February.

Closely correlated with the performance of US equities, the Israeli currency lost nearly 12% last year in its worst performance since 1998. The political backlash against the government’s plans to reshape the judiciary has also become a factor, stoking a depreciation that makes imports more expensive.

In its statement on Monday, the central bank highlighted that “exchange rates have been characterized by considerable volatility” but didn’t specify how that may have affected its decision.

Jonathan Katz, macro strategist for Leader Capital Markets, said the shekel’s volatility was likely “the swing factor” for the Bank of Israel.

“It’s pretty clear that unless there’s a reasonable compromise on the judicial reform issue in the near term, one that the government and opposition can agree on, we’ll see continuing pressure on the shekel,” Katz said.

–With assistance from Harumi Ichikura and Alisa Odenheimer.

(Updates with analyst comments starting in eighth paragraph.)