The Monetary Committee of the Bank of Israel decided to raise the bank's interest rate by 0.75% per year last week. The committee, headed by Prof. Amir Yaron, raised the rate to the steepest it's been in the last 20 years.
Bank of Israel's interest rate will rise to 2% per year while the prime interest rate in the banking system will increase to 3.5%. Most analysts have estimated that Yaron would settle for a 0.5% increase per year.
Why raise the interest rate?
This decision to raise the rates also took into account growth data, worldwide interest rates and employment data, and it was only accepted after the release of the current inflation data — which reached 5.2% annually following the July index.
However, perhaps the most pivotal factor in the decision was the timing: It seems that the decision was leaked, so right before it was officially published, the shekel fell 1% to the dollar. After the publication, the shekel's value returned and even strengthened.
What does raising the interest rate do?
The high-interest rate may lead to the cooling of demand for goods and reduce inflation pressure, although the price increase isn't due to increased demand pressure but rather increases in prices for commodities.
Since January, the interest rate has increased by 1.9% annually. The main blow of the interest rate increase is to consumers and credit card companies that have outstanding balances.
Even before the increase, mortgage repayments jumped by NIS 400 a month. The current increase will increase mortgage repayments by an average of NIS 200 per month.
If the average mortgage is 1 million shekels and a third of it is linked to the prime interest rate (the basic bank interest rate), then the monthly repayment of the loan will jump on the prime component alone by NIS 200 per month.
There will be additional price increases in the future for other loan components. The interest rate increase will also make interest on overdraft and credit card payments more expensive. Yet interest on funds in the right balance (plus) will increase only marginally, at a rate estimated at 0.1%-0.2% annually.
Despite increases in interest rates, with inflation, wage earners aren't earning more, either through raising the minimum wage nor through moderate price increase agreements for basic goods previously used as an economic tool.
Dr. Ron Tomer, the president of the Manufacturers Association, called on Yaron to freeze the continuation of interest rate increases for the next three months, insisting that though the current increase is justified, but it could lead to a recession and damage to credit consumption in the economy.