The Bank of Israel on Monday raised the interest rate for September 2009 by 0.25 percentage points to 0.75% in an effort to bring inflation to within the target range and strengthen the economy's ability to establish a firm base for the recovery in economic activity, while supporting financial stability.

"In the last few months, inflation measured over the previous twelve months was above the target range of price stability of 1% to 3%. A considerable part of the deviation was the result of non-recurring factors (increased tax rates, including VAT, and water prices), but even excluding these elements, inflation was close to the upper limit of the target range," stated the central bank. "Twelve-months-forward inflation expectations, both those of forecasters and those derived from the capital market, have fallen to around the midpoint of the target range. Nevertheless, it is thought that the reduction in twelve-month inflation expectations is due not only to the continued widening of the output gap, but also to expectations that the Bank of Israel will increase the interest rate in the next few months."

Since the beginning of the year the Consumer Price Index has increased by 3.2%, and measured over the previous twelve months, by 3.5%. At the beginning of August forecasters' inflation expectations twelve months forward and expectations derived from the capital market increased to around the upper limit of the target inflation range of 1% to 3%, but following the publication of the July CPI they declined sharply, and reached close to the midpoint of the range. Thus, last week the forecasters' twelve-month forward inflation expectations averaged 2.3%, and expectations calculated from the capital market were 2.2%. The averages of forecasters' inflation expectations are for an increase of 0.6% in August and for a decline of 0.2% in September. According to these forecasts, inflation over the previous twelve months is expected to remain around the upper limit of the target range in the next few months.

The central bank noted that the most recent data on real activity in Israel strengthen the assessment that there has been a turnaround, although there was great uncertainty regarding the expected rate of growth.

"Interest rates of the leading central banks around the world are expected to remain unchanged till the end of the year, and possibly even to the middle of 2010. However, unlike in Israel, inflation in those countries is expected to remain low both this year and next," explained the central bank. "In this situation, the Bank of Israel's decision to increase the interest rate for September by a quarter of a percentage point strikes a balance between the need to moderate inflation and the need to continue to support the recent recovery in economic activity, given that unemployment is expected to continue increasing in the next few months."