Because of rapid dollar gain?
No, even though the dollar has gained 4.2% since the beginning of the year after a 4.5% gain in December, this is not the reason for the interest rate hike. Bank of Israel has been explaining in no uncertain terms for seven years that the bank has no exchange rate target or interest in affecting the rate.
In the past decade the economy has gradually shifted to a completely open currency regime in which the exchange rate is determined by market forces. The central bank only has an inflation target and interest rates are the key instrument the bank uses to maintain price stability.
The dollar gain, in and of itself, is not a reason to raise or lower interest rates. The only reason investors tie the dollar gain to the rate hike is concern the exchange rate rise will lead to continuous price hikes ¿ which would force Bank of Israel to raise interest rates.
Because of huge January CPI increase?
No, despite the fact that the January index is the highest since 1993, it contains no reason to raise interest rates. On the contrary, if we remember that the dollar gained 9.6% in December and January, then we see a mere 1.1% CPI as reinforcing estimates there is no inflationary pressure on the Israeli economy to date.
The January index rise reflects mostly ¿technical¿ increases in items that are dollar-denominated for various reasons or automatically updated by the Central Bureau of Statistics in keeping with the dollar rate. This is not an index that reflects inflationary pressure or an index that reflects loss of control over price stability.
So maybe because of huge expected rise in February CPI?
No, despite the fact there is a good chance the February CPI will also be high and the two months together will come to 2%, that doesn¿t amount to reason to raise interest rates either.
Bank of Israel has explained many times, and with good reason, the difference between a one-time price increase stemming from a sharp change in the exchange rate and ongoing price inflation.
The exchange rate leap and the one-time hike in prices are two natural and expected phenomena that occur at the end of a period of disinflation. The disinflation process in which interest rates remain high is characterized by ongoing currency revaluation during the process and sharp devaluation near its end. Bank of Israel always knew one day interest rates would come down, the public would adjust its asset portfolio, the exchange rate would rise ¿ and there would be a one-time hike in price levels. That is not inflation.
Then the guilty party is the Treasury "cooking up" another huge budget deficit.
No, that doesn't explain the fact that Bank of Israel is seriously considering raising interest rates either. For the past several years the central bank always assumed the government might not meet its fiscal commitments. That is why the central bank always waited to see what the government did, not what it promised, before taking any action.
If Bank of Israel remained true to its policy, it would have taken into account two months ago ¿ when it slashed interest rates by a dramatic 2% -- that the government might, again, exceed its deficit target. Assuming it did remain true to policy, the 2% cut was made despite the bank's full awareness of such a possibility.
This leaves only one reason for Klein to consider interest rate hike.
And it is a simple one: Klein has to correct his mistake in lowering interest rates by 2% two months ago following a meeting with the prime minister. Now the capital and currency markets are telling Klein that in order to regain his credibility, so they will be convinced he is still completely committed to price stability ¿ they want to see him raise interest rates.
If Klein hadn't lowered interest rates by 2% after a meeting with the prime minister and continued to act as he had until now, then the rise in the exchange rate would not have created concerns about a public rush on the dollar, but would have been accepted naturally ¿ and he wouldn¿t have to raise interest rates now.
If Klein hadn't lowered interest rates by 2% after a meeting with the prime minister, then it would be clear to everyone that a few high price indices are natural in an economy ending a long disinflation period, and Klein wouldn¿t have to raise interest rates now to prove the two indices are not harbingers of continuous price increases.
If Klein hadn't lowered interest rates by 2% after a meeting with the prime minister, then he wouldn't have to explain in numerous interviews for the press that he has no ego and acts only out of consideration for price stability. Until that one lousy decision, no one doubted Klein's commitment to price stability or even asked about his ego.