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Israeli inflation rose at the fastest pace in more than five years in May, reflecting higher costs of food and fuel and making it more likely the central bank will raise interest rates.

Prices rose 5.4 percent from a year earlier, compared with an increase of 4.7 percent in April, the Central Bureau of Statistics in Jerusalem said today. Prices rose 0.7 percent in May from the previous month.

Bank of Israel Governor Stanley Fischer has said he may raise interest rates further to bring the consumer price index back inside the government target of 1 percent to 3 percent annually. The annual rate has been above that range for six months now. The central bank boosted its base lending rate a quarter-point to 3.5 percent in late May.

“Fischer likely will raise rates by 25 basis points next week,'' Ori Greenfeld, chief economist at Clal Finance Batucha Investment Management Ltd. said by telephone.

Economists polled by Bloomberg before the CPI data were divided about how the Bank of Israel will act when Fischer makes his next rate decision on June 23. Six out of 11 surveyed said the bank will keep the main lending rate at 3.5 percent, while the others forecast either a quarter- or half-point increase.

Israeli inflation has quickened on the back of higher world prices for energy and other commodities, compounded by rising domestic demand as a strong shekel encourages people to buy imported products. Israeli GDP grew at a 5.4 percent annual rate in the first quarter, which was faster than economists had forecast.

Outlook

Finance ministers from the Group of Eight nations yesterday said at a meeting in Osaka, Japan that surging food and fuel prices have replaced the credit squeeze as the biggest threat to the world economy.

Israeli inflation will probably be about 3.5 percent in the next 12 months and back in the target range during 2009, Greenfeld said.

The yield on the government's Shahar bond due in 2016 finished at 5.91 percent today, up 0.59 percentage point from three months earlier, pointing to expectations for higher inflation and rates quick payday. The inflation data were released after the close of bond trading.

Fischer's efforts to steer inflation back into the target have been made more difficult by the weakening influence of the exchange rate on domestic prices and by an economy that has growth faster than he expected so far this year.

Shekel

Last week, Fischer said the bank was having difficulty gauging inflation as the dollar's weakness has caused home sellers and landlords to stop writing contracts in the U.S. currency, thereby reducing the exchange rate's impact on home prices. Housing accounts for about a fifth of Israel's CPI.

The shekel has gained about 19 percent on the dollar in the past year, reaching an 11-year high against the U.S. currency May 30. It has since pulled back about 6 percent to close June 13 at 3.4248 to the dollar.

For the second month in a row, inflation encompassed nearly all categories of goods and services, Meirav Yiftach, head of inflation statistics at the bureau, said at a news conference today.

“We had global rises in food and energy that were offset somewhat by the weaker dollar, which reduced rents and travel costs,'' she said.

Inflation ran at a five percent rate in the three months through May, she said.

Fresh fruit was the biggest contributor to inflation in May, rising 16.7 percent and accounting for 0.23 percentage point of the index. Energy followed, climbing 4.9 percent and contributing 0.21 point. The housing subindex rose 0.1 percent.

The 5.4 percent annualized rate compared with median estimate of 10 economists surveyed by Bloomberg for an increase to 5.5 percent.

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