Bank of Israel steps up inflation fight with 0.4 point rate hike

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New Israeli Shekel banknotes are seen in this picture illustration taken November 9, 2021. REUTERS/Nir Elias/Illustration

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JERUSALEM, May 23 (Reuters) - The Bank of Israel raised its benchmark interest rate (ILINR=ECI) by a bigger-than-expected 0.4 percentage points on Monday, the latest move in its aggressive battle against rapidly rising inflation amid strong economic growth and a tight labor market.

The suddenly hawkish central bank lifted its key rate to 0.75% from 0.35%. In April, policymakers had raised the rate from 0.1% - an all-time low where it had stayed for the prior 15 decisions since a 0.15 point reduction at the outset of the COVID-19 pandemic.

"We are determined to return inflation to its target," Bank of Israel Governor Amir Yaron told Channel 12 television when asked about the aggressive hike, which was in line with moves by other central banks dealing with price pressures.

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"At the same time I want to say and reassure, inflation in Israel is 4% ... among the lowest inflation rates in the world."

The 11-year high in April of 4% is well above the government's 1%-3% annual target range, while inflation expectations for the coming year remain around 3.5%. Israel's economy shrank in the first quarter after a robust 2021, but the jobless rate has fallen to 3.1%.

The central bank dismissed an annualised contraction of 1.6% in economic activity in the first three months of 2022, citing 15.6% growth in the fourth quarter.

"The Israeli economy is recording strong growth, accompanied by a tight labor market and a continued increase in the inflation environment," the bank said in a statement. "The (monetary) committee has therefore decided to continue the gradual process of increasing the interest rate."

It added that the pace of rate hikes will be based "in accordance with activity data and the development of inflation."

All 14 economists polled by Reuters had said they expected the monetary policy committee to raise rates, 11 of them predicting a 0.25 point increase with the others projecting a 0.4 point rise.

"Even after the hike, rates in Israel are still at the Federal Fund rate's lower bound," said Yonie Fanning, economist at Mizrahi Tefahot Bank.

"Economic activity in Israel is continuing at a high level," the central bank said. "Indicators of economic activity continue to show levels close to potential, and the pandemic’s effect on the economy has declined significantly."

It added that the war in Ukraine and COVID lockdowns in China are increasing inflationary pressure, and leading to a slowdown in the pace of global economic activity.

Analysts expect the key rate to rise 1.5 to 2 points in the next year.

The shekel gained 0.5% versus the dollar on Monday to a rate of 3.34 after weakening nearly 5% against the U.S. currency and 1.4% versus the euro since the last Bank of Israel policy decision on April 11.

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Reporting by Steven Scheer and Ari Rabinovitch; Editing by Toby Chopra and Bill Berkrot

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