Tuesday, December 29, 2009

What is common to Israel, Australia and Norway?

Stanley Fischer raised interest rates in Israel for the second time in relatively quick succession today. After the 0.25% rise, they now stand at 1.25%.

The only other countries that have managed to raise rates are Norway and Australia. Unlike Israel, Australia and Norway are resource rich countries and have seen increased economic activity based on the slowly emerging global pick up in demand, which has been reflected in commodity prices recently.

Most of you will know the famous joke about biblical Moses that he took the wrong turn after the exodus from Egypt bringing the Children of Israel to Israel, rather than the oil rich countries surrounding. As a result, Israel is sadly not rich in physical resources.

We must then ask the question why Israel is feeling the need to increase rates well ahead of the major developed economies.

The most obvious reason for this is the improving state of the domestic economy and what Mr Fischer is seeing which is rising asset prices (equities, bonds and real estate). It's clear that he does not want to squander the advantage created for Israel by avoiding the meltdown that has become so prevalent in other economies, and protect Israel from future asset bubbles.

All of this sounds like good news, and indeed reflects a generally positive outlook for the Israel economy etc.

There are of course some downsides to this. The main effect of increasing interest rates will inevitably be a further strengthening of the shekel against the dollar and probably also Sterling and the Euro. At a time when the exporters (predominantly technology based companies) are trying to restore growth into overseas markets this will come as a blow, increasing relative cost of the workforce at home, and reducing competitiveness abroad.

This is the reality of life and my advice to managers within our portfolio and others that we speak to is to adjust, as we do not see a weaker shekel over the near or medium term.

This means bringing productivity in line with the prevailing power of the shekel to protect Israel's competitiveness as an exporter.

Whilst the unions and some industrialists may complain and call for government intervention (In other words money and subsidies) this is a nice problem to have and we should be thankful that we are not caught in the trap of zero interest rates, with little or no prospect of real economic growth.

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