Bank of Israel
The Israel central bank in Jerusalem. An economic upswing in Israel has propelled employment, output and consumption to levels last seen before the pandemic. Image Credit: bloomberg

Israel’s central bank surprised most economists by delivering its biggest increase to interest rates in two decades, tightening monetary policy for the fourth straight meeting in the face of the fastest inflation since 2008.

The monetary committee on Monday increased its benchmark to 2 per cent from 1.25 per cent, exceeding the forecasts of all but two economists surveyed by Bloomberg. The decision makes this the longest cycle of rate hikes since 2008.

“The Israeli economy is recording strong growth, accompanied by a tight labour market and an increase in the inflation environment,” the central bank said in a statement. “The increase in inflation is broad-based, with contributions from most CPI components.”

The shekel maintained losses after the announcement and traded 0.2 per cent weaker against the dollar.

Governor Amir Yaron is looking to navigate an increasingly buoyant domestic economy that’s ripe for higher rates but with inflation set to benefit from the shekel’s surge and a letup in global energy prices. The central bank has tried to get ahead of inflation by increasing the pace of monetary tightening every time it raised rates this year.

Although economists were almost unanimous that policy makers would opt for a smaller half-percentage-point move, Goldman Sachs Group Inc. and Bank Leumi were among those who couldn’t rule out a bigger rate hike.

“The upward surprise in inflation and the stronger than expected growth data, coupled with the continuing strength of the labour market in the economy, support, even more so, a continued process of rate hikes,” Leumi economists Gil Bufman and Yaniv Bar said in a note to clients before the rate decision.

An economic upswing in Israel has propelled employment, output and consumption to levels last seen before the pandemic.

The shekel, which is closely correlated with the performance of US equities, has also staged a comeback since the start of July in what’s been the world’s second-biggest appreciation against the dollar during the period.

For much of the first half, however, declines in the Israeli currency fed into inflation by raising the cost of imports.

The central bank’s research department issued revised forecasts in July that lifted this year’s estimate for inflation to 4.5 per cent, an increase of a full percentage point from April’s projections.

Price growth has been above the government’s 1-3 per cent target since January. Last month, it topped all forecasts and accelerated to 5.2 per cent on an annual basis, the fastest since October 2008.

Markets and analysts see scope for much higher borrowing costs ahead. One-year interest rate swaps are pricing in an increase near 2.8 per cent a year from now.

The central bank’s research team predicts the key rate will reach 2.75 per cent in the second quarter of 2023, while Goldman sees it at 2.5 per cent by the end of this year.