Bank of Israel's Flug Failed to Win Consensus on Rate Cut Last Month

Bank of Israel minutes show one dissenting voice, which is echoed by Hapoalim’s chief economist.

Bank of Israel Governor Karnit Flug failed to win over all of the Monetary Committee before the central bank made a surprise interest rate cut at the end of last month, according to minutes of the deliberations released on Monday.

Three of the six members of the committee, which determines interest policy, backed Flug in supporting a reduction in the rate of 0.25% to 0.75%, but one unidentified member dissented.

The latter urged the others not to change the interest rate, citing the “stability in the exchange rate in the past month, positive current indicators in both the domestic and global economies, the low unemployment rate and the risk of continued home price increases.”

The central bank has been wrestling with a strengthening shekel, which is hurting the country’s export competitiveness, as well as with the risk to banks and borrowers as rising home prices spark record demand for mortgages. Cutting its base lending rate, as the bank did at the end of February, would help weaken the shekel, but lower the cost of home loans, encouraging more borrowing.

In fact, the shekel reached its highest level against the dollar since 2011 in the days after the rate cut, appreciating about 1.8% during the week. On Monday, however, the dollar reversed course after seven trading days and appreciated 0.43% to a Bank of Israel rate of 3.474 shekels. The euro also strengthened 0.43% to 4.822 shekels.

Nonetheless, forex trader FXCM Israel warned that the turnaround for the U.S. currency was likely temporary because the dollar has been losing ground in global markets.

“If the weakening of the dollar globally continues, the dollar-shekel rate is likely to sink to a new low, and the Bank of Israel won’t be able to stop it,” FXCM said Monday. “The fragility of the dollar-shekel rate will only increase the appetite of speculators to profit from the trend, and to sell dollars against the shekel.”

Meanwhile, Leo Leiderman, chief economist at Bank Hapoalim and a leading candidate to replace Stanley Fischer as Bank of Israel governor last year, attributed the shekel’s strength not to speculation, but to the fact that the Israeli economy is in good shape. Israel has a surplus in its current account and is enjoying a strong inflows of foreign investment, in large part due to its newly discovered and exploited natural gas finds, he said.

"It would be very difficult to be a country with a current account surplus and capital inflows like Israel’s and also have a depreciating local currency," Leiderman told the DC Finance investment conference in Tel Aviv. “A situation like this has never occurred throughout in history.”

Under the circumstances, he added, lowering interest rates will not influence the exchange rate. If Israel wants to support exports, it must do so through its fiscal policy, and not the central bank’s monetary policy, he said.

Bank of Israel minutes from last month shed little light on why the Monetary Committee voted to lower the base rate. The report cites a host of reasons, including a decline in the inflationary environment, slower economic growth in Israel and globally, and a weak labor market as well as the appreciation of the shekel.

Daniel Bar-On
Tomer Appelbaum