The Bank of Israel raised the interest rate by a further 0.75 % to curb inflation, which jumped to 5.2 % this month.
The rise in the consumer price index and galloping inflation at an annual rate of 5.2 % have raised many questions. In addition, today the Bank raised interest in Israel from 0.75 % in one fell swoop to a rate of 2 %.
Why has this happened, and what can we expect?
Why is inflation exploding at the moment?
Inflation is a rise in prices in the economy.
The reasons for inflation are generally divided into two:
- Problems in the supply sector (problems in the supply of services that make them more expensive)
- Problems in the demand sector (private capital is increasing and the public is willing to pay more for services. As a result, prices rise).ALSO READ: How does the "Israel Tax Deduction" work?
Inflation in Israel: 3 reasons
The inflation we're seeing now is a complex one, because it comes from three areas combined.
- Firstly, in the area of supply - problems with the supply of goods such as energy, gas and wheat caused by the war between Russia and Ukraine.
- The second reason also comes from the supply side - problems in the supply chains that came to a standstill during the Corona crisis. As the epidemic recedes, this cause is being resolved.
- The third reason is strong demand - there's more "free money" and the volume of purchases is increasing.
These reasons will seem strange to some audiences, as many barely close the month. However, during the Corona period, several processes took place that together led to the fact that there would be plenty of "free money" for purchases. Among them: government support for employers and employees increased, public spending on vacations and entertainment decreased, and when restrictions were lifted, many rushed to fill the gaps.
All this, plus the shortage of available workers which has led to a significant increase in wages on the open market. All these factors have led to excess liquidity, resulting in purchases and price rises.
Is it possible to predict the inflation rate?
Inflation has many devastating consequences, and its evolution is difficult to predict. At the beginning of the year, forecasts were rather pessimistic, and in Israel it was estimated that it would reach 3 %.
But now, inflation has jumped to 5.2 %, well above forecasts. It's worth noting that the world's central banks prefer to deal with inflation while it's still relatively low, and not just after it has surged, as is currently the case.ALSO READ: Property depreciation in Israel: Breaking down the purchase price
Why do interest rates in Israel rise during inflation?
Raising interest rates makes money more expensive - that's its purpose. Therefore, increasing the price of mortgages, overdrafts and loans - is not a side effect, but the goal. The aim is simple - the less "free money" there is for purchases and similar needs, the lower the demand and the more moderate the prices.
When money becomes more expensive, the public avoids withdrawing their capital and prefers to keep it in savings, partly to avoid paying high interest rates in Israel.
In addition, the incentive to borrow decreases, as repayments are higher.
Good to know!
The more the Bank of Israel raises interest rates, the stronger the shekel becomes, as the Israeli government shows that it wants to watch its inflation.
The Bank of Israel intervenes from time to time to "buy the dollar", thereby boosting the dollar's value against the shekel. But will it do the same for the Euro? What interest would the Israeli government have in doing so? When the pound sterling fell several years ago, Israel did not devalue its currency, so will it do the same for the euro?
What do we need to know about rising interest rates in Israel?
Every practice you've adopted needs to be recalculated: whether it's taking out a loan or borrowing as leverage to invest in real estate and the capital market.
Rising interest rates lead to declines in both the equity and debt markets, mainly because other alternatives are slowly emerging to provide returns in solid channels.
Another thing to be aware of is the accentuation of the difference between real and nominal interest during a period of rising inflation. Until recently, they were similar when inflation was zero. But now, there is a significant gap between them, which affects financial decision-making. For example, there's an investment that earns 4% nominal interest a year, if you deposit the money and don't spend it. But when there's inflation of 5.2% a year, that's a negative real interest rate - nominal interest rate minus inflation, so it's not at all certain that it's an attractive investment as it was in the past.
How is the rise in interest rates in Israel determined?
The Bank of Israel is examining a number of parameters in preparation for Monday's decision, including three: the first, the inflation rate.
As mentioned, the increase in interest rates is aimed at suppressing inflation, and will continue until we see a significant decrease.
The second, the shekel/dollar exchange rate - the strengthening of the shekel is highly problematic in a country that depends on significant dollar-denominated exports. (Hi Tech, Gas...).
And the third parameter is the state of the economy - is there growth or recession. At the same time, as always, the Bank of Israel is looking at what the US Fed has done and how this affects the exchange rate.
Right now, as the inflation rate continues to rise, so will interest rate hikes. And let's be honest - respect for mortgage holders is not an essential parameter in the Bank of Israel's decision.
On the contrary, the increase in mortgage prices is a step that should limit the amount of mortgages they can take out, and lead to a recession in rising property prices.
It's worth remembering that while the process of raising interest rates is weighing on public opinion, it's a good one, given that the last decade has been characterized by an unusual situation of zero interest rates.
Although a zero interest rate creates "cheap money" that stimulates consumption and growth, it comes with serious side-effects for economies. Among them: higher property prices (because it's better to invest money in an apartment than in a bank account), increased household debt (because loans are cheap, so it's easier to take them out), a clear preference for consumption over long-term savings, and taking more risk in market capital in order to achieve returns.
What's more, the absence of interest leads to a situation in which many companies survive only because of cheap and good financing conditions, not because they have a business justification.
All these side effects have been very strongly evident over the past decade, and as interest rates rise, they will diminish.
What's stopping banks from raising interest rates in Israel?
When interest rates rise, the fear that the economy will go into recession increases in central banks. Private consumption is a central driver of economic growth, and when the bank uses tools to remove the incentive for private consumption, the fear is that people will simply buy less and, as a result, companies will earn less and lay off workers. Naturally, a wave of layoffs could worsen the recession as the unemployed earn less.
Consequently, when raising interest rates, governors look at the situation in the labor market before rushing to raise interest rates more aggressively.
In the current case, you can see the strength of the labor market and demand. Since the disappearance of the corona, many companies, particularly in the hotel and tourism sectors, have needed more manpower to keep up with strong demand, so that the labor market is not blocked by further interest rate rises.
However, the area showing the weakest signs is technology, where we are seeing a large wave of redundancies.
As a result, central banks, including the Bank of Israel, monitor what's happening in the market before raising interest rates.
Why do banks also make fixed interest rates more expensive?
Those faced with taking out a new mortgage are discovering that the banks are going to raise all interest rates in Israel for mortgage holders, including the non-indexed fixed interest rate.
The reason: the Bank of Israel's interest rate represents the risk-free interest rate, i.e. the risk that banks take when granting a mortgage.
As a result, banks value the various risks at a certain margin above this risk-free interest rate, and if it rises, so does the non-indexed fixed interest rate offered at the starting point.
However, for those with an existing mortgage, their interest rate on this route will not change.
What to expect in the future:
- Increase in the amount of mashkenta to be paid each month.
- The current rent exemption ceiling of 5196 Nis, which is indexed in 2022, will increase in 2023. Landlords will be able to increase their rent without paying taxes. They'll do it anyway, as their loan repayments to the bank are becoming increasingly expensive.
- Companies wanting to borrow will have to pay more and more to the bank. Some who can't will have to cut back, lay off staff or go out of business.
- Curbing the rise in real estate prices in Israel.
- Limit the amount of money in circulation in the country and thus reduce inflation.
1. Think about renegotiating your rates (switch a larger portion to a fixed rate). It is possible that rates will continue to rise in the coming months.
2. Consider early repayment if you have no other investments in mind.
3. If you're selling your own property, this new decision is likely to create a shake-up in the Israeli real estate market, so be careful not to wait too long to sell.
- Bank of Israel interest rate: 2%
Current interest rate: 3.5%.
- Example: the bank offers you Prime +2.5% = you owe it 6%.
Your questions - our advice
- How can companies protect themselves against inflation?
- Is paying back your loans the best way to go at the moment?
- Towards a real estate upheaval in Israel? Where to invest?