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15:15 30Jan2007 RTRS-Dollar's role in Israel too great -central bank
JERUSALEM, Jan 30 (Reuters) - The dollar plays too large a role in Israel's economy, making it tough to implement monetary policies, the country's central bank said on Tuesday.
In its semi-annual inflation report, the Bank of Israel noted that 29 percent of the consumer price index is related to the dollar-shekel exchange rate, with housing comprising 22 percent.
"Continuing indexation makes managing monetary policy harder, as external shocks that are unconnected to Israel or sharp, frequent changes in the exchange rate -- also without any trend -- make economic planning difficult and monetary planning particularly so," the bank said.
Israel adopted a partial dollarisation of its economy in the days of hyperinflation in the 1970s and 1980s. But despite a sharp disinflation trend in the 1990s that has brought inflation to virtually zero, many prices -- such as real estate rentals and sales of previously occupied houses -- are still quoted in dollars.
Legal services, car rentals and functions such as wedding receptions are also based on the dollar.
The Bank of Israel said such a situation was a"market failure", adding the continued indexation of non-tradeable goods had no economic justification.
In 2006, overall inflation was influenced largely by the dollar-shekel <ILS=>. While costs of many domestic items, such as food, jumped, inflation was minus 0.1 percent -- well below an official annual target range of between 1 and 3 percent.
But when stripping out dollar-linked housing prices, the CPI rose 1.3 percent last year.
The central bank said the steep appreciation of the shekel against the dollar in the second half of the year was a key factor in sending annual inflation from nearly 4 percent early in 2006 to zero by year's end.
"The intensity and the speed of the forces affecting prices were not expected," Bank of Israel Governor Stanley Fischer wrote in a letter to lawmakers that accompanied the report.
The shekel surged from a low of 4.75 early in the year to 4.2250 per dollar by the end of 2006.
The central bank said, however, that monetary policy is more effective when the dollar has a strong influence on inflation.
"If the exchange rate is more sensitive to a difference in interest rate, then changes in the local interest rate will have a more rapid effect on prices via the exchange rate and will make it easier to achieve the target inflation within a short time," the Bank of Israel said.
((Reporting by Steven Scheer, Editing by Gerrard Raven; Jerusalem newsroom, +972 2 632 2210, steven.scheer@reuters.com; Reuters Messaging: steven.scheer.reuters.com@reuters.net))
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