The Bank of Israel has become the first global central bank to raise interest rates as they moved their benchmark to .75% from .50%. They cite 3 main factors for moving. 1)Over the past few months, inflation data was above the target range of price stability, 2)the most recent economic data has shown a turnaround with still a question of the expected rate of growth, 3)interest rates are expected to remain unchanged at the leading central banks 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.” They believe the move to raise “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.” They say .75% still represents an expansionary monetary policy.
The consensus out of Jackson Hole was that central banks would keep policy easy for a continued period of time so this may be an outlier but is still worth noting that rates have only one way to go from here. To illustrate how easy the Fed is, current inflation expectations in the TIPS are expected to be almost 1.9% over the next 10 years. With the fed funds rate at zero to .25%, real rates are currently negative by 1.5-2%. Historically, the fed funds rate is 2-3 % points above the rate of inflation. We’re obviously not in normal times but when it comes time for the Fed to exit its current strategy, it will not be a quick process.
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