Three decisions in 36 hours: the major economies are on the way to changing the direction of interest rates

Until March of this year, we thought that the words “interest rate increase” belonged to the past. The feeling was that the central banks were able to tame the monster of price increases that has been raging since the corona virus, and as part of the wave of optimism, interest rates in the western world have consistently fallen. But the rosy forecasts were shattered with the outbreak of the military conflict between the US and Iran. The Middle East was on fire, the global oil “faucet” in the Strait of Hormuz was blocked, prices soared – and the central banks realized that the victory celebrations were too early.

A hawk tone around the globe

At the center of the decisions will be the central bank of the USA, the Federal Reserve. On Wednesday at 21:00 Israel time, the Chairman of the Fed, Kevin Warsh, will appear and probably announce the increase of the interest rate by a quarter of a percent to 4%.

The Fed has no choice. On Friday, it was announced in the US that the consumer price index excluding food and energy (core inflation) rose by 0.3% in August compared to July, above the forecast of economists. The figure reinforced expectations for an interest rate hike, and the markets are now pricing in a 90% probability of an interest rate hike.

Investors also remember the words of Fed Chairman Warsh in a speech on August 28 in Jackson Hole, when he said that policymakers will have “more to do” if they do not receive new assurances that inflation is on track towards the Fed’s 2% target.

When Warsh was sworn into office in May, President Donald Trump encouraged him to be “absolutely independent.” This week will put Warsh on a collision course with the president, who just last week said: “High interest rates put the US at an unfair disadvantage, and I will not let that happen! Our interest rate should be the lowest in the world.”

The next interest rate decision, on Thursday morning, is in the UK. The central bank is expected to leave the interest rate unchanged (3.75%), but will probably adopt a hawkish tone and leave the door open for increases against the background of the rise in energy prices and the worsening of tensions in the Middle East. The bank estimates that inflation will stand at 3.2% in the fourth quarter, well above the 2% target, and the markets are already pricing in at least one interest rate increase of 0.25 percentage points by the end of the year.

And finally, Japan’s interest rate decision will arrive, which records its own dramatic story: it abandoned the era of zero interest rates, jumped its interest rate to 1.00% last June, and is now about to raise it to 1.25% – a record since 1995.

This trend continues the direction outlined by the European Central Bank which has already hit the markets with two swift interest rate hikes that jumped it to 2.5%. The last one was last week. Bank President Christine Lagarde warns that inflation in the Eurozone will remain high in the near future.

How will Israel be affected?

The ever-widening gap between the Bank of Israel’s interest rate and interest rates in the world may increase the risk of the shekel weakening and inflation expectations rising. However, Ofer Klein, head of the economics and research department at Harel Insurance and Finance, claims that the market already embodies most of the increase in interest rates, so there will only be an impact on the shekel or the local bonds if there are surprises. “The more the interest rate gap increases, the more the Bank of Israel needs to lower interest rates, because this gap puts pressure on the depreciation of the shekel, and therefore pushes up import prices and inflation,” he says.

Ronan Menachem, Chief Markets Economist at Mizrahi Tefahot Bank, claims that “as the interest rate in the US tends to rise, while the interest rate in Israel tends to fall or at least remain the same, this may have an effect in the direction of the depreciation of the shekel against the dollar.” But, he points out, there is also a factor that can actually contribute to the strengthening of the shekel: “A low fiscal deficit in terms of GDP works in favor of the shekel, while in other countries the high deficits and debts work against the currencies theirs”.