The Bank of Israel raises the interest rate for May 2006 by 25 basis points to 5.25 percent

The Bank of Israel raises the interest rate for May 2006 by 25 basis points to 5.25 percent
The interest rate for May 2006 will rise by 25 basis points to 5.25 percent. The decision to raise the interest rate is intended to help maintain price stability within the limits of the target of between 1 percent and 3 percent inflation a year as determined by the government.
Background conditions
Economic data indicate continued rapid growth, seen in all sectors of the economy. This growth is expected to continue against the background of continued relatively rapid growth in the global economy and the expectation that the government's macroeconomic strategy will continue.
The CPI in the past 12 months increased by 3.6 percent, slightly above the upper limit of the inflation target. The CPI has increased 0.6 percent since the beginning of the year, a slightly faster pace than most of the forecasts and than the seasonal path consistent with the inflation target. Inflation expectations for the next twelve months, derived from the capital market and economists' forecasts, are that inflation will be close to the midpoint of the target range, under the assumption that the interest rate will continue to rise, as is reflected in the bond market.
In the financial markets, the NIS has appreciated against the dollar by 2.6 percent since the beginning of April. The strengthening of the NIS was due mainly to the trend of a weakening dollar globally. In the bonds market, long-term nominal yields rose by 10 basis points, a lower pace than the rise in equivalent yields in the US, such that the yield spread contracted. In addition, share prices went up in April and the Tel Aviv 100 Index rose by 4.9 percent.
Globally, the gradual process of rising interest rates continued in the major economies, which is expected to continue in the near future. The trend of rising world input prices, and particularly oil prices, continued with the price of oil increasing in April by 9.6 percent.
Until the budget for 2006 is approved, government expenditure will continue to be governed by the law on the absence of an approved budget, in which monthly expenditure is limited to one-twelfth of the previous year's budget. On the revenues side, the continued rapid rise in real economic activity lead to a growth in tax revenues.
The main considerations behind the decision
The decision to raise the May interest rate was based on the existence of pressures acting to raise prices, which can be seen already in the relatively rapid rise in prices in the past 12 months and in the first quarter in particular. The main factors that could affect the inflation environment in the future are:
  Rate of growth in the economy and the expansion in demand. The expansion in demand in the economy and the process of exhausting surplus production capacity create upward pressure on prices and nominal wages in the future.
  Rising input prices––particularly of oil––globally. As long as this trend continues, the risk that this will translate into rising prices in the economy grows.
It is noted that the strengthening of the NIS against the dollar in recent weeks is likely to provide a moderating force on inflationary pressures. The continued strengthening of the NIS against the dollar is influenced by both domestic and global factors. In this context, the Bank notes that there is an expectation that interest rates will continue to rise globally.
The Bank of Israel will continue to monitor economic developments closely––including developments in budget policy––with the intention of achieving the government's price-stability target. Subject to this, the Bank will continue to support the attainment of a range of objectives of macroeconomic policy, particularly with respect to increasing employment and growth. In addition, the Bank will continue to support financial stability.