Bank of Israel Stirs Up a Storm in the Markets by Doing Nothing

Defying speculation, central bank holds interest rate unchanged, announces no program of quantitative easing.

Michal Fattal

The Bank of Israel didn’t lower interest rates and didn’t announce a program of quantitative easing on Monday, but the absence of any news still stirred up a tempest in the foreign currency and stock markets.

The central bank said it was leaving its base lending rate at a record low 0.1% and that, for now, it was taking no other measures to stimulate the economy or weaken the shekel. The Monetary Committee said it would “examine the need to use various tools” if necessary.

Clarifying the point, Bank of Israel Governor Karnit Flug told the Calcalist financial daily on Monday that speculation triggered by a HSBC report last week that the central bank was about to embark on a QE program was premature.

“We didn’t just put that sentence into the rate announcement,” she said. “It’s important to us that everyone is aware that in this abnormal monetary environment, options are on the table and we aren’t referring to it in a pro forma way. But we very much hope that conditions will be such that we don’t get there, because there’s all kinds of uncertainty surrounding the use of tools like this.”

The HSBC bank report had pushed the Tel Aviv Stock Exchange and the dollar higher since it was released last Thursday, so the news that the central bank was not acting caused everything to go into reverse.

The dollar pushed as high as 4.05 shekels on Monday morning – its highest level since August 2012. But as word emerged that the central bank would not be acting, the dollar sunk as much as 2% from its Bank of Israel rate last Friday.

Monday's official rate was set at 1.0180, down 0.9% from Friday; in late trading, it tumbled below the 4 shekel barrier to 3.9541 shekels, a loss of 2.2% from Friday.

The euro’s movements were even more dramatic. During trading Monday, it rose 1% to a Bank of Israel rate of 4.3737 shekels, extending two days of gains and bringing its total appreciation to 3.3%.

The euro’s gains were all the more significant since, the week before, it had sunk to a 13-year low against the shekel of 4.23, after the European Central Bank launched its own QE program. With Monday’s rate announcement, the euro began weakening: in late trading it was 4.3344.

On the stock market, the benchmark TA-25, which had rallied over the previous two trading sessions, was lower all day as traders concluded that the HSBC prediction was wrong. The index moved down sharply at 4 P.M. with the actual rate announcement, but then staged a small recovery. It ended down 0.14% for the day, at 1,620.35 points.

“The Bank of Israel decided to wait and examine additional economic data – mainly growth, employment and inflation, which are all expected to be higher,” said Eldad Tamir, CEO of Tamir Fishman, an investment house.

“The decision signals a clear stand, which is that the Bank of Israel is ready and willing to take whatever steps are needed to weaken the [shekel] against the basket of currencies,” he added.

The Bank of Israel uses a trade-weighted basket of currencies to measure the shekel’s value in terms of international trade. While the shekel has been losing value to the dollar since last summer, the effect on Israel’s economy and its export sector – which needs a weaker currency to be price-competitive in world markets – has been neutralized by its gains on the euro.

Under a QE program – like the ones conducted by the U.S. Federal Reserve since 2008 and the European Central Bank earlier this month – the Bank of Israel would buy government bonds and print shekels. The aim is to stimulate economic growth and weaken the shekel.

QE acts much the same way as lowering interest rates does, adding a new weapon to a central bank’s arsenal at a time when it has cut its rates to near-zero.

Ofer Klein, chief economist at Harel Insurance & Finance, believed the central bank would not institute any change in monetary policy while it waits for inflation to return after several months of deflation. “The bank will wait at least until the publication of the next consumer price indexes, which are expected to be positive – especially April’s, which was very low a year ago – before it decides on any policy changes,” he said.

In fact, the Bank of Israel said on Monday that Israel’s economic outlook was looking better. The bank’s economists said that gross domestic product would grow 3.5% in 2016, up from a previous forecast of 3%. For 2015, it held its growth forecast at 3.2%, but said unemployment would decline to 5.3% (compared with 5.5% in the previous forecast).

It also said consumer prices for all of 2015 would show a 0.1% drop, but that inflation would resume later in the year and reach the lower end of the government’s target range of 1% to 3% annually.