Surprise! Bank of Israel Cuts Base Lending Rate

Central bank reduces rate a quarter-percentage point to 0.75%, its lowest since 2009.

In a surprise move, the Bank of Israel lowered its base lending rate on Monday for the first time since last September, citing low inflation and concerns about economic growth.

The base lending rate will go down by a quarter of a percentage point to 0.75% as of Thursday, the bank said. That will make it the lowest since November 2009 when the world economy was in the midst of a deep recession.

The Bank of Israel also cited the weakness of the U.S. dollar against the shekel and slow economies in the United States and Europe, two of Israel’s biggest export markets, for its decision.

“Various indicators of activity in January pointed to some recovery, but consumer confidence indices continued to signal pessimism, and data continued to indicate a lack of growth in employment and wages in the business sector,” the Bank of Israel said in a statement.

All 11 economists polled by Reuters had predicted no change in rate for March, with most believing the easing cycle that began in September 2011, when the key rate was 3.25%, was over barring a sharp downturn in growth.

News of the rate cut had an immediate impact of the exchange rate, with the dollar bumping up from 3.4981 shekels to 3.5158 shekels in the early evening. Besides encouraging borrowing that can spur economic growth, lower interest rates discourage speculators from buying and holding the shekel, thereby reducing demand for the currency.

The Bank of Israel’s move comes in contrast to the expected direction of interest rates in the United States, where the Federal Reserve is gradually scaling back its quantitative easing program, making the way for rate rises.

Even as they were taken by surprise by Monday’s rate cut, many economists said it was likely to be a one-time event. Uri Greenfeld, chief economist at Psagot Investment House, said most indicators pointed to an improving economic outlook globally, which would in turn lift Israeli economic activity.

“It seems like the cycle of interest rate cuts has reached its end,” he said about the rate cut. “Only in the event of a sharp strengthening of the shekel will the Bank of Israel consider another reduction in rates.”

He cited the Bank of Israel statement pointing to a pick-up in economic activity since the start of January as well as the relatively small appreciation of the shekel since last September’s rate cut. In addition, the central bank has to be careful not to encourage rising home prices by reducing the cost of mortgages.

The central bank noted that home prices had risen 8.1% in the past year as the number of sales and level of mortgages had grown.

“The low [January] consumer price index seems to have overcome any concerns about heating up home prices because the Bank of Israel is more concerns about the low inflation and slower growth,” said Ilan Artzi, head of investments at investment house Halman Aldubi.

But, Uri Klein, head of the economic desk at Harel Insurance & Finances, said the central bank had opted not to lower rates since last September even though most of the factors it cited had not changed in the past months.

“The factors that tipped the balance were the weak economic data from the United States and the possibility that the European Central Bank will act the same [and lower its lending rates] in response to the low inflation in the euro bloc,” Klein said.

The Bank of Israel said that after two quarters of rapid growth, recent U.S. economic data had been “disappointing while in Europe there are growing concerns of deflation.

Nevertheless, Klein said he doubted the Bank of Israel would lower its rate again, unless the shekel strengthened appreciably.

Bloomberg