All eyes were on Karnit Flug on Monday. Not only was the Bank of Israel governor holding her first news conference since announcing she would not seek a second term but she was widely expected to signal when Israeli interest rates would start rising.
On the latter, Flug indicated that wouldn’t happen anytime soon and that the record low base rate of 0.1% that’s been in place for more than three years would remain so for some time. That confounded expectations in the bond market, where yields have been rising for more than a month
As expected the Bank of Israel’s Monetary Committee voted to leave the rate at 0.1% until its next meeting at the end of August. The bank’s economics department, meanwhile, revised upward its economic growth forecast for this year to 3.7% from a previous 3.4% and said GDP would expand another 3.5% in 2019, unchanged from its previous forecast.
The consumer price index is widely expected to enter the government’s target range of 1-3% inflation annually when the June CPI is published next week. But on Monday, Flug said that wouldn’t be enough for the bank to act. Instead she talked about the need for the “entrenchment” of inflation before rates would go up.
“As inflation tends to be volatile, a situation where the expected inflation environment is very close to the lower bound of the target is not the entrenchment of inflation within the target range,” she told a news conference. “The second point is that in order to establish that the inflation environment has become entrenched in the target, the [monetary] committee will want to be certain, as much as possible, that the return of inflation to the target range will not last for only a few months.”
She warned that a premature rise in interest rates before inflation is entrenched could delay its entrenchment in the target and ultimately slow the path of an increase in the interest rate as well.
That said, the Bank of Israel’s economists said the base rate would rise to 0.25% at the end of this year, implying a single rate hike in the fourth quarter. Another rise will occur in the 2019 third quarter, this time to 0.5%, they said.
“We see the Bank of Israel’s interest rate forecast as a dovish message to the markets,” said Jonathan Katz, chief economist at Leader Capital Markets. “The Bank of Israel doesn’t share the assessment of the market and some forecasters.”
The dollar, which had weakened 0.5% on Monday to a representative rate of 3.6180 shekels, turned higher in after-hours trading to 3.6320.
Regarding her decision on a second term, Flug hinted at the tensions with Finance Minister Moshe Kahlon, which flared up last March when unnamed Kahlon aides warned he would not support her for a second term when her current one expires in November.
“When I took upon myself the post of governor, I knew that it would involve disagreements and debates. I never flinched from it, and I don’t do so now,” she said. “When we have a well-established professional position, we say it clearly.”
She said her announcement last week was timed “not to be too early but to provide enough time for there to be an orderly and dignified process” for naming a new governor.
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