Israel becomes first developed economy to up interest rates

JERUSALEM, Aug. 25 (Xinhua) -- Israel was one of the world's first economies to cut interest rates when the world financial crisis reared its head last year, and on Monday it became the first developed nation to subsequently increase its lending rate.

The Bank of Israel announced a 0.25 percent rise of its overnight lending rate, to 0.75 percent, or as Israeli biggest-selling daily newspaper Yediot Aharonot put it, "a 50 percent rise in its interest rate."

The effects of this increase will not be that strong in actual terms, suggested Gad Lior, the senior macroeconomics correspondent of Yediot Aharonot. However, it will likely have a major ripple effect around the world.

Lior predicts that many other developed economies might follow suit, despite the decision of no change of the rate in the United States, taken last week by Ben Bernanke, the chairman of the board of governors of the Federal Reserve.

While the Israeli move may be seen as something of a positive sign regarding the world's economy, it is of course not good news for people with a mortgage. For someone on a relatively low income with a 100,000 U.S. dollars mortgage payable over 20 years, a 0.25percent annual increase can have a significant effect.

Israel's industrialists, a powerful lobby, are already up in arms against the decision. Their main concern is exports. A rise in the rate means a stronger shekel, Israel's currency, and that makes Israeli exports less attractive to potential purchasers.

"We really hoped he wouldn't do it, because he knows full well that this quarter of a percent (rise) won't halt inflation or the increase in prices, but that it will dramatically affect the competitive ability of Israeli exports," said Zvi Plada, a member of the presidium of the Israel Manufacturers Association.

However, the feelings of the industrialists are secondary if at all relevant for the Bank of Israel. Its function as an independent agency is to ensure price stability.

Inflation has been rearing its ugly head in Israel, as the interest rate has come down over the last year. It now stands at some 4 percent on an annual basis, while the government's target for the calendar year is one to three percent.

The Bank of Israel's main consideration is to ensure that goal is met.

The first sign of a possible rate rise came on Monday morning, when the central bank reportedly purchased greenbacks to the turn of as much as 250 million U.S. dollars. That was aimed at offsetting the effects on the currency markets of the impending statement on the interest rate rise.

That purchase did little to please the manufacturing exporters, according to Plada. Despite the acquisition, the dollar lost some 0.5 percent of its value on Tuesday.

News of the increase in the key lending rate was made public late Monday afternoon, after the domestic stock markets had closed. The central bank is always careful to ensure there are no leaks about its decision on interest rates ahead of time, in order to prevent jitters and even sharp knee-jerk reactions on the markets.

These decisions are taken by the board of the central bank, but it is its governor who has the final word.

Israel currently has one of the world's highest-regarded economists as its central bank governor. A graduate of the London School of Economics and MIT, Stanley Fischer served in the late 1980s as the chief economist of the World Bank. From there he went on to become the first deputy managing director of the International Monetary Fund, before being appointed the vice-chairman of Citigroup.

Since becoming governor of the Bank of Israel in 2005, Fischer has proved himself to Israelis a superlative economist but not necessarily a great manager, according to Lior.