Bank of Israel Rate Cut Fails to Do Magic on Exchange Rate

Analysts laud move as needed spur for economy but say it’s not enough to weaken the shekel.

Bloomberg

The Bank of Israel’s surprise decision to cut its base lending rate for August to its lowest in five years may not be enough to solve the problems of a slowing economy and a muscle-bound shekel, analysts and one central bank official said on Tuesday.

“We believe that lowering the interest rate alone isn’t enough to effect any change in the exchange rate even if it was an important step for encouraging consumer demand and investment, which have eroded significantly in the past year,” said Yossi Fraiman, CEO of Prico Risk Management.

The central bank said on Monday it was lowering its key lending rate by 0.25 percentage point to 0.5%, its lowest since the depth of the 2008-09 global financial crisis. But in foreign currency trading Tuesday, the dollar posted a slight appreciation of 0.03% to a Bank of Israel rate of 3.4260 while the euro edged lower by 0.03% to 4.6029.

On the Tel Aviv Stock Exchange, share prices did nothing more than edge higher on Tuesday (see story on this page). Bond prices rose sharply for a second day, with the government’s 10-year shekel bond rising 0.13% to cut its yield to 2.66%. That narrowed its spread with equivalent U.S. treasury debt, which is now just 20 basis points.

The shekel has gained about 2% this year to reach its strongest against the dollar in about three years. The strong shekel has been blamed by industrialists for hurting exports by making the products and services less price competitive. Although it hasn’t happened, in Israel’s trade-oriented economy slowing or declining exports could result in job cuts.

“It’s a pity that the Bank of Israel missed an opportunity to accelerate the depreciation of the shekel with an interest rate cut combined with moves that could have created a domino effect and moved the dollar to 3.48 shekels or higher,” said Fraiman.

Tacitly acknowledging that this week’s rate cut might not be sufficient, Nadine Baudot-Trajtenberg, the Bank of Israel’s deputy governor told Bloomberg News, it may not be the last. “At this point we don’t feel that there is a need to do more than that,” Baudot-Trajtenberg said. “But in principle there is still more room, particularly given that inflation is so low.”

Ronen David, economist at Mercantile-Discount Bank, said that the latest data point to a decline in imports, consumer spending, low inflation expectations and a strong shekel, all of which supports lower interest rates. But, he warned, the rate cut threatened to spur demand for homes and cause prices to rise further.

“The question even before they acted is whether in the current environment of low rates and the failure of rate cuts to influence the exchange rate it would make more sense to employ more creative solutions in the foreign currency market as the treasury has been trying to do in the real estate market,” David said.

With reporting by Shelly Appelberg