Israel outperforms Fed with bigger rate hike than forecast

(Bloomberg) —

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Israel extended its longest cycle of monetary tightening in decades, beating a US Federal Reserve rate hike for the first time since it began raising the cost of borrowing in April.

The central bank raised interest rates from 3.75% to 4.25% on Monday. Most economists polled by Bloomberg were expecting a quarter-point increase, marking the Fed’s latest move.

The Monetary Committee did not signal an end to its tightening cycle, saying only that it had “decided to continue the process of rate hikes” with the eighth straight hike. The shekel was trading 0.8% weaker against the dollar as of 5:18 pm in Tel Aviv and is on course to close at its weakest since early November.

With borrowing costs already at their highest since 2008, the Bank of Israel is now confronted with a surprise acceleration in inflation and economic growth. The rebound is adding to a series of political turbulences that have helped the shekel become the worst-performing currency in the Middle East this month after the Lebanese pound.

The Bank of Israel began raising borrowing costs in small increments from November, although inflation shows little sign of slowing down. Governor Amir Yaron has signaled that policymakers are “determined” to bring price growth back into its target range and expects a slowdown after February.

Gains, which have been above the official 1%-3% target range for over a year, unexpectedly accelerated to 5.4% a year last month.

Along with real estate inflation, higher energy costs for households were among the biggest price drivers in January.

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

Klein said he did not rule out a rate hike to 4.5% at the next central bank meeting in April “on whether the devaluation of the shekel is continuing or slowing down and how the world’s central banks are dealing with it.” “

Market expectations are that monetary policy will tighten further. Israel’s one-year currency swaps suggest investors see the federal funds rate rising to around 4.5% a year from now.

Although expected to weaken in the coming months, inflation is also being weighed down by the shekel, the strength of which was once a key factor in restraining consumer prices. So far in February, it’s down about 3% against the dollar.

Closely correlated with US stock performance, the Israeli currency fell nearly 12% over the past year, posting its worst performance since 1998. The political backlash to the government’s plans to overhaul the judiciary has also become a factor and has depreciated fueled, which made imports more expensive.

In its statement on Monday, the central bank highlighted that “exchange rates have been characterized by considerable volatility” but did not specify how this might have affected its decision.

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

“It is quite clear that unless there is a reasonable compromise on the issue of judicial reform in the short term, one that the government and opposition can agree on, we will see continued pressure on the shekel,” Katz said.

–Assisted by Harumi Ichikura and Alisa Odenheimer.

(Updates with analyst comments starting in eighth paragraph.)

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