Bank of Israel Governor Stanley Fischer raised the benchmark interest rate for the first time in four months in a bid to cool housing prices which he says could develop into a bubble.
Fischer yesterday unexpectedly increased the rate by a quarter percentage point to 1.75 percent. Only five of 16 economists surveyed by Bloomberg had predicted the decision, while eleven expected no change.
“He is very concerned about housing prices,” Jonathan Katz, a Jerusalem-based economist for HSBC Holdings Plc who predicted the raise, said in a telephone interview. “He is aware that monetary policy has contributed to the froth.”
Fischer raised the key interest rate by a percentage point between August and March as the economy recovered from the impact of the worst global recession since the Great Depression. During the past year, housing prices have risen 21 percent and the Organization for Economic Cooperation and Development warned in a May 26 report of a “speculative” property bubble in Israel.
The shekel strengthened to 3.8201 against the dollar at 9:14 p.m. in Tel Aviv from 3.8480 just before the decision was announced. The benchmark Mimshal Shiklit note due January 2020 rose 0.04 shekel to 106.12 at the close in Tel Aviv. The yield on the 5 percent security was 4.51 percent. It reached a low of 4.49 percent on July 22.
Most bonds are likely to be hurt by the rate increase, said Amir Kahanovich, an economist at Clal Finance Investment Management Ltd. in Tel Aviv. “Bonds in general hate a surprise increase in interest rates, especially CPI-linked bonds with longer maturities,” he said.
Rents, as measured in the housing component of the Consumer Price Index, have risen by 4.9 percent in the past 12 months, double the 2.4 percent increase in the overall index, the Central Bureau of Statistics said July 15.
The rate of increase in housing prices “continues to be very rapid, and if prices continue to rise at the current pace they are likely to deviate from the level consistent with the basic economic conditions,” the bank said in its statement yesterday.
While the best way to prevent the property market from overheating would be to increase the supply of housing, it isn’t likely that there will be a significant increase in construction of new homes, Fischer said July 19. “Prices have risen over 20 percent in the past year and if they continue to rise at this pace we will have a bubble,” he said.
The central bank published a draft directive on May 24 that will require banks to increase provisions for mortgages with a high loan-to-value ratio, in a bid to slow rapidly rising house prices. The directive called on the banks to re-examine the risk in their housing credit portfolio.
Fischer’s decision yesterday was also triggered by the rise in inflation expectations, the statement said. Forecasters’ expectations of inflation over the next 12 months rose from an average of 2.6 percent at the end of June, to an average of 3.2 percent in mid-July, the Bank of Israel said. The government’s target is for annual inflation of 1 percent to 3 percent.
“That’s a red flag for him,” said Katz, who sees two more rate increases by the end of the year. “Maybe the market thinks that he is behind the curve.”
While inflation slowed to 2.4 percent in June, inflation expectations for the next 12 months, as derived from the bond market, are at 3.3 percent, said Arie Tal, chief strategist at Alumot-Sprint Investment House Ltd. in Herzliya, near Tel Aviv.
Israel began to recover from the global crisis ahead of many developed countries. The economy is expected to grow by 3.6 percent this year, according to a June 6 Finance Ministry forecast, and by 3.8 percent next year.
Unemployment fell to a 1 1/2-year low in May, declining to 6.5 percent from 6.6 percent the previous month. Unemployment is likely to drop to 7.3 percent this year, from 7.6 percent in 2009, the Finance Ministry said in the June 6 forecast.
Israel’s benchmark TA-25 stock index has gained about 18 percent in the past year, led by Perrigo Co., the world’s largest maker of non-prescription, store-branded drugs, which nearly doubled.
In August, Fischer became the first central bank governor to raise rates in response to signs of a recovery. Other countries to follow suit include Australia, India and Norway.
“It seems that the governor has changed his position and he is giving greater importance to inflation expectations than to continued support of growth in the economy,” said Dan Ron, chief investment officer of Tel Aviv-based Tachlit Investment House.