Bank of Israel Holds Base Rate, but Lowers Economic Outlook

Move dashes market hopes for a cut, sending the dollar 1% lower against shekel.

Emil Salman

The Bank of Israel on Thursday kept its base lending rate unchanged for October, but also left markets hoping a reduction may still be in the works, as the central bank sharply lowered its growth outlook for the Israeli economy.

In a rare public comment on the rate decision, Bank of Israel Governor Karnit Flug cited a long list of factors that contributed to the decision – a slower world economy, near-zero Israeli growth in the second quarter and negative inflation. But at the same time, she pointed to data showing economic growth may be picking up and stressed that deflation was due to one-time factors, like lower electricity rates and a cut in the value-added tax going into effect next week..

“In light of all these, the monetary committee was of the opinion that the very low level of the interest rate, 0.1%, provides, as of now, the support required to achieve the policy objectives,” Flug said in the statement.

Meanwhile, however, the bank’s research department cut its forecast growth for Israeli gross domestic product to 2.6% this year, down from the 3% estimate it gave just three months earlier. It attributed the revision to the surprising weakening of exports in the first half of the year.

The central bank said it expected exports to recover as well capital spending, nevertheless it lowered its GDP growth outlook for 2016 to 3.3% from the 3.7% it forecast in June.

The bank’s decision to hold interest rates unchanged at 0.1% for the seventh month caused the dollar to weaken in late trading by more than 1% and was trading at 3.9230. On the Tel Aviv Stock Exchange, where shares were being pounded by a global stock market slide, the benchmark TA-25 slipped another notch at the end of the day to end down 3.5% (see story on page 14).

The markets had been reasoning that the odds of a rate cut to zero or even a negative number were increasing as Israel’s economic outlook grew more cloudy and the United States Federal Reserve opted last week not to raise its interest rate for now.

“The Bank of Israel will be forced to lower its rates in the next few weeks in light of the zero inflation and low economic growth in Israel and the world as a whole,” said Ilan Artzi, investments manager at Halman-Aldubi.

The decision to hold the rate for now is “leaving the last bullet in the magazine,” he said. “The rate now is nearly zero and it’s not clear that a further reduction would help. In addition, lowering the rate further would cause a further increase in real-estate prices, which is completely inappropriate right now.”

As Flug noted in her statement, Israeli consumer prices have fallen 0.4% in the past 12 months, but she noted that not counting the energy and food prices, the CPI rose 0.8% and that the decline in the headline CPI was likely “transitory.”

The Central Bureau of Statistics revised its figure for second-quarter economic growth to just 0.1%, but Flug noted that there were one-time factors, like a strike at Israel Chemicals, that hurt exports and noted the labor market remains strong.

Idan Azoulay, investments manager at the Epsilon investment house, said the Bank of Israel held off a rate cut not only for the declared reasons that it is concerned over rising housing prices, which have accelerated recently, but is also quietly worried that the government will exceed its budget deficit target next year.

“We expect interest rates will remain low for a long time,” Azoulay said.

Ayelet Nir, chief economist at the Yetzirot investment house, lauded the Bank of Israel for not rushing to lower the lending rate.

“Like other central banks worldwide, which also are in a holding pattern while they await further data before deciding on monetary policy, the [Bank of Israel] monetary committee is waiting to see whether the economic freeze in the second quarter is a one-time event or signals a new trend,” she said.

In spite of the sharp cuts in the central bank’s economic-growth outlook, its economists said consumer spending would continue to grow briskly, by 5% in 2015 and 4.2% next year. Unemployment will average 5.1% both years.

“GDP growth in 2015 is expected to be led by private consumption, which is expected to experience high growth, among other things as a result of the low interest rate and due to the income effect of the decline in energy prices,” the bank said.

The Bank of Israel interest rate is expected to remain at 0.1% until the first quarter of 2016 and then begin rising.