Bank of Israel Governor Ends Interest Rate Uncertainty With Unusual Statement

The statement halted the shekel’s rise against the dollar and the euro in midday trading

Governor of the Bank of Israel Amir Yaron, Jerusalem, March 31, 2019.
Emil Salman

“I estimate that for an extended period there will be no decision to raise interest rates,” the Bank of Israel governor said Wednesday.

Amir Yaron spoke after a rapid rise in the shekel in the past few days and expectations of a cut later Wednesday – after press time – to U.S. rates.

The chief banker’s statement halted the shekel’s rise against the dollar and the euro in midday trading Wednesday.

Yaron’s statement to the media was unusual. It was published after Yaron discussed the matter at the central bank monetary committee’s weekly meeting, which he leads.

The announcement came after the central bank took criticism for not intervening in the foreign currency market for several months, in order to moderate or halt the shekel’s rise against foreign currencies. A strong shekel hurts Israeli exports while increasing the buying power of Israelis traveling abroad.

In its last rate decision, on July 8, the bank reiterated, as it had for months, its intention to raise rates. Yaron said then the hike could be soon.

And yet, the changing macroeconomic data made that scenario less likely. On July 15, Israel’s consumer price index for June was published, showing that inflation was at a low of 0.8% for the previous 12 months, which is below the government’s price stability target range of 1-3% annual inflation and Yaron’s goal of 2%.

Over the course of the month, the risks to global financial stability became more acute as well, including the growing likelihood of a no-deal Brexit and a U.S. rate hike, which would be the first in more than a decade. Thus, the Bank of Israel research division’s forecast published July 8, which stated that the central bank was likely to raise interest rates three times by the end of 2020, started appearing increasingly unlikely. Economists began predicting that the central bank may actually have to cut rates in the short term.

Israel’s interest rate is set by the central bank’s five-member monetary committee.

“During the previous interest rate decision, the monetary committee believed, given the information we had at the time, that the conditions for a rate increase could be there during one of the upcoming decisions,” Yaron stated. “Yet, we felt that in the face of the significant, current uncertainty, we may need to continue our expansionary monetary policy” – that is, not raising interest rates – “for a longer period.”

Israel’s last interest rate increase was in November 2018, when the rate was increased to 0.25% from its previous 0.1%, the all-time low rate that Israel had previously maintained for years, after lowering rates amid the 2008 global financial crisis.

Yaron’s announcement Wednesday is an example of “future intent,” one of the tools at the central banker’s disposal to set monetary policy.

Prior to the announcement, the U.S. dollar and the euro had been declining sharply against the shekel; following the announcement the losses halted and reversed course by the end of trading.

The dollar closed at 3.49 shekels, only a very slight loss, after trading as low as 3.47 shekels Wednesday. The dollar has lost 6% against the shekel since the beginning of 2019.

The euro closed down 0.05% against the shekel, at 3.89 shekels to the euro, after trading as low as 3.87 over the course of the day. The euro is down 9% against the shekel for the year.

The shekel has gained 7.5% against a representative basket of currencies so far this year. That figure includes the currencies of Israel’s main trading partners.

Market players believe speculators were closely watching the central bank over the past few days, and were responsible for part of the shekel’s most recent gains.

Discount Bank stated Wednesday that it was the central bank’s conduct that set the tone for the shekel’s appreciation over the past few days. “The central bank was relatively passive, and didn’t significantly change its message regarding monetary policy. This is an unusual approach compared to the broad messages from other central banks in the west and other parts of the world,” said the commercial bank’s market strategist Shmuel Katzavian.

On Wednesday, the central bank avoided directly intervening in currency trading, in keeping with the policy choice that Yaron made at the beginning of his term. Prof. Asher Belles, a former senior official at the central bank, defended Yaron’s approach of intervening as little as possible in currency markets, even when the shekel is trading at record highs.

“There are significant differences in the policy of Yaron and [his predecessor] Karnit Flug,” said Belles. “Flug’s policy of buying dollars was contentious, even if this action was taken less over the past few years. Yaron witnessed the negative potential of this policy. It’s not clear that currency trends can be countered by buying dollars – it’s not clear this is an effective tool,” he said.

He noted that the central bank currently holds $120 billion in its foreign currency reserves, and that this sum is worth less than when the bank bought it. Because the bank bought the dollar at a relatively high rate, the result is that the public subsidized the purchases by some 50 million shekels, he said.