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Cablegate: Interest Rate Hike and Third Quarter Data Evidence

VZCZCXRO1695
RR RUEHROV
DE RUEHTV #2561/01 3311519
ZNR UUUUU ZZH
R 271519Z NOV 09
FM AMEMBASSY TEL AVIV
TO RUEHC/SECSTATE WASHDC 4379
RUEATRS/DEPT OF TREASURY WASHDC
RHEHNSC/NSC WASHDC
INFO RUEHXK/ARAB ISRAELI COLLECTIVE

UNCLAS SECTION 01 OF 02 TEL AVIV 002561

SIPDIS

STATE FOR NEA/IPA GOLDBERGER AND FRELICH; EBB/IFD FOR
PERDUE; TREASURY FOR BALIN

E.O. 12958: N/A
TAGS: ECON EFIN IS
SUBJECT: INTEREST RATE HIKE AND THIRD QUARTER DATA EVIDENCE
ISRAEL'S CONTINUED ECONOMIC RECOVERY

1. Summary: On November 23, the Bank of Israel (BoI)
announced a 0.25 percent increase in interest rates, bring
the BoI rate to 1 percent in a move intended to return
inflation to well within the target range yet low enough to
support the continuing economic recovery. Preliminary third
quarter economic data from the Central Bureau of Statistics
indicates 2.2 percent growth, an increase in exports and a
surge in imports. Even unemployment declined slightly in the
third quarter, while labor participation remained basically
unchanged. The BoI has continued to limit its intervention in
the foreign exchange market and remains cautious about a
monetary policy that would put additional downward pressure
on the dollar. The OECD recently expressed its reservations
about the BoI's previous interventions but has yet to comment
on the BoI's more recent actions. These encouraging signs
indicate that the recession was truly mild for Israel and
that economic recovery is less tentative than first assumed.
However, most commentators note that a fully global recovery
is the surest sign of success for Israel's own. End summary.

2. The Central Bank intended to strike a balance between
inflation considerations and supporting the economy's path of
recovery in its decision to raise the interest rate by .25
percent. The target range for inflation is 1-3 percent, with
Governor Stanley Fischer's ideal annual rate at the mid-point
2 percent. The inflation rate for the last 12 months was 2.9
percent, and but inflation rose 3.6 percent for the first 12
months of 2009. The BoI's press release accompanying the
rate hike said the low interest rate of 1 percent continues
the "accommodative monetary policy that is intended to
support further economic recovery, ... as well as placing
inflation firmly within the target range." The release also
noted that inflation is expected to be above the upper limit
of the target in the coming months, as 12-month forecasts
increased slightly following the October CPI. Economic
forecasters expect that the BoI will continue to increase
interest rates by 0.5 percent over the next three months,
gradually working up to 2.5 percent by the end of 2010 unless
significant exchange rate or other macroeconomic changes
occur.

3. In a recent meeting with Econoff, Dr. Karnit Flug, Head
of Research at the Bank of Israel said that while economic
results in the third quarter were good, the real question is
sustainability. Following growth of 1 percent in the second
quarter, real GDP growth is at 2.2 percent, while per capita
GDP grew slightly by 0.3 percent after four quarters of
negative readings. Exports were up more than 21 percent
after increasing 15 percent in the second quarter, and
imports grew by 61.9 percent. Private consumption was up by
almost 9 percent and investment in fixed assets increased by
over 23 percent. Unemployment was at least less bad,
declining to 7.8 percent from 8 percent in the second
quarter. This was the first decline in unemployment since
the third quarter of 2008. Labor participation rates were
steady with the notable exception of Jerusalem, which usually
has the lowest participation rates and among the highest
poverty rates. Jerusalem's labor participation rate inched
up 1. 9 percent in the first 10 months of 2009, which may
indicate some early success of pilot projects to incorporate
ultra-orthodox Jews into labor market.

4. The Bank's November 23 interest rate announcement noted
that the dollar had strengthened against most currencies
during the last month. In the period between the BoI's last
monetary policy discussion and the November 23 rate hike, the
shekel weakened against the dollar by 3.2 percent, by 2.2
percent against the euro and by 2. 9 percent against the
basket of currencies. As the BoI policy is now to refrain as
much as possible from forex intervention, they are cautious
about monetary policy that might put downward pressure on the
dollar. BoI contacts insist there is no dollar-shekel target
exchange rate (the current shekel/dollar rate is about 3.8)
and note the Governor's desire to move in the direction of
infrequent to zero intervention in the forex market. In
reference to the Bank's actions prior to September 2009, the
OECD wrote in a November 19 announcement that the Bank of
Israel's "continued foreign exchange interventions risk
bringing additional inflationary pressures and damaging
policy credibility and coherence." The monthly foreign
exchange reserve report indicates that the Bank has in fact
decreased USD purchases. In October, the Bank purchased USD
1.27 billion compared with USD 1.6 billion in September and
USD 4 billion in August. The OECD is expected to release a
final report in December that softens its criticisms of BoI
actions in the forex market.


TEL AVIV 00002561 002 OF 002


5. Following the rate increase, some commentators, such as
Michael Sarel, focused on the significant increase in exports
as the critical factor in pushing Fischer to raise rates. As
long as the export situation improves, the Bank's concern
about a strengthening shekel is diminished. Despite the
increase, real short term rates remain very low, similar to
levels in the U.S., U.K and Canada where the crisis was
deeper and inflationary pressures more moderate. Sarel warns
that inflationary pressures could become significant within
the next year or two if rates remain so low. The rate
increase also provided the pres an opportunity to praise
Stanley Fischer's stewardship of the economy, citing local
and international economists' assessments that Fischer's
continued presence at the helm of the Bank is critical to
Israel's continued economic recovery. If the figures speak
for themselves, his continued tenure is his for the asking.

MORENO

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