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How will Fed rate hike affect the Bank of Israel?

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The decision by the Open Market Committee of the US Federal Reserve to raise the US central bank’s interest rate by 0.75% brings the rate to a peak that the US economy has not seen since 2008. In addition, the Federal Reserve announced a revision to its interest rate forecast, according to which the rate will be 4.6% at the end of next year, far above the previous forecast rate of 3.8%. After the announcement, stock indices on Wall Street became volatile, falling by up to 1.8%.

“The Fed raised its interest rate in line with most expectations, and significantly raised its rate forecast for the coming years. It now estimates that the rate will rise to 4.4% at the end of 2022 (the previous forecast, in July, was 3.4%); to 4.6% at the end of 2023 (the previous forecast was 3.8%); and 3.9% at the end of 2024 (the previous forecast was 3.4%). This indicates that, like chairperson Jerome Powell, most of the Federal Reserve members believe that interest rates will remain at contractionary levels for a long period,” explains Bank Hapoalim chief strategist Modi Shafrir.

“On a more encouraging note for the markets,” Shafrir adds, “the Fed’s forecast for the end of 2025 is 2.9%, and the long term nominal neutral rate forecast remains at 2.5%.”

Shafrir believes that the Federal Reserve’s new forecasts will lead the Bank of Israel to raise its interest rate forecast as well, to 3.5% for the end of next year, from 2.75% in its current forecast.

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Oppenheimer Israel co-CEO Harel Gillon sees the Federal Reserve’s move as having a much broader goal than bringing down inflation. “This is a copy-paste from the previous declaration in July. The wording is very similar. Although the Fed didn’t surprise the market, in my view this is a bigger event. The central bank took inflation and decided to use it to wean the market off the quantitative easing that started in 2008,” he says. After the interest rate announcement, the stock indices on Wall Street fell by 1% or so, but then rose slightly. Gillon explains this by the fact that the Federal Reserve was not aggressive in relation to expectations, and the market expects and hopes that the rate of inflation will subside.

“Now is the great test of the Federal Reserve, and only in a few months’ time will we know if it is succeeding. The huge quantities of money poured into the economy during the Covid-19 pandemic, the big problems in the supply chain, and the war in Ukraine, have led to a change of mindset and to the realization that policy has to change. The Fed wants to wean the market off cheap money, and no-one knows how this experiment will end.”

And what about the consequences for the Bank of Israel? Gillon presents a somewhat unusual stance, and argues that it does not absolutely have to raise its interest rate as well in its next announcement on October 3. “The rise in the CPI has halted for now, we are coming up to elections, and if the government wants to stop inflation it can do so by cutting the excise duty on fuel. The CPI reading for September is also expected to be low, as in August, when it was negative. I’m not sure that we have to run after the US central bank. It’s true that the shekel-dollar exchange rate will go up a little, but that’s not necessarily a bad thing. The Bank of Israel has large foreign currency reserves, and exporters will also gain from it.”

By contrast, Ronen Menachem, chief economist and head of research and investments at Mizrahi Tefahot Bank, says, “In general, the Fed’s announcement has indirect consequences for the Bank of Israel, which has adopted the front loading policy that prevails in most of the world, and so the Fed’s move increases the chances that the interest rate will rise here as well, probably by 0.5%.”

Published by Globes, Israel business news – en.globes.co.il – on September 22, 2022.

© Copyright of Globes Publisher Itonut (1983) Ltd., 2022.

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