Bank of Israel Chief Sends Dollar Sharply Lower After Remarks on Monetary Policy

U.S. currency loses as much as 1.7% as market judges Flug insufficiently determined to fight shekel appreciation.

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Karnit Flug holds up a newly designed 50 shekel banknote during its presentation at a news conference in Jerusalem, September 10, 2014.
Karnit Flug holds up a newly designed 50 shekel banknote during its presentation at a news conference in Jerusalem, September 10, 2014.Credit: Reuters

The dollar lost as much as 1.7% of its value against the shekel on Monday after Bank of Israel Governor Karnit Flug gave her first-ever press conference on monetary policy, which analysts said dashed hopes the central bank would act decisively to prevent a further appreciation of the shekel.

The dollar traded as low as 3.7685 shekels at about 5 P.M. Monday before staging a small recovery to 3.7807, which still left it down 1.4%. The Tel Aviv Stock Exchange also turned lower and bond prices fell (see The Ticker on this page).

The Bank of Israel’s decision to leave its base lending rate at 0.1% for July was expected, but Flug’s address disappointed the markets, which had expected the bank would make a stronger statement about employing quantitative easing – or what Flug referred to as “unconventional tools” – to stave off a further appreciation of the shekel.

“In light of the expected path of inflation returning to within the target range and the stabilization of a moderate rate of growth, it appears that the probability that we will be required to use unconventional tools in the near future has declined,” Flug said, although she hedged by adding, “The economic world is one of unexpected shocks, and the well-known expression ‘never say never’ is still relevant.”

The central bank is caught between several contradictory policy goals – one to ensure an overly strong shekel doesn’t weigh on Israeli exports and deter economic growth, which would incline it to cut rates or employ QE. Another goal is to ensure inflation doesn’t exceed the government’s target range of 1-3% annually and a third is to ensure cheap money doesn’t encourage mortgage-borrowing and home buying, sending prices even higher. Those two policy goals would point to higher interest rates.

In her news conference, Flug acknowledged the shekel’s effective exchange rate had appreciated 2.7% in the quarter, but pointed to other factors hurting exports right now. She focused on forecast inflation, noting that after months of negative consumer price indices inflation in the previous three months had returned to the target range.

“The governor stressed that because inflation was returning to the target range and economic growth was steadying, the chances of the bank needing to use unconventional tools in the near future have fallen, even if the bank hasn’t rejected them entirely,” said Ofer Klein, chief economist at Harel Insurance & Finance.

“As a result of her remarks, the shekel strengthened more than a percentage point against the basket of currencies,” he said.

Many economists responded negatively to the remarks and, even though the news conference was supposed to clarify the Bank of Israel’s views on monetary policy and the economy, they left them disagreeing about whether the bank would eventually have to undertake QE policies or eventually cut the base lending rate, which has been at its record low level since February.

“It appears the Bank of Israel prefers to remain passive in the global currency war even though the latest GDP data for the first quarter were lowered and declines are continuing in exports,” said Yariv Konforti, investment managers at the Tamir Fishman investment house.

European central banks have been cutting their interest rates often to negative levels in a bid to maintain economic growth, which could force the Bank of Israel to match them. However, expectations, as Konforti noted, are that the U.S. Federal Reserve will be raising its rate soon.

Ilan Artzi, chief investments manager at Halman Aldoubi, said he believed Flug would be forced to cut interest rates in the next few weeks because of the currency wars. He said that could come as soon as next month, if the shekel continues to appreciate. But Shmuel Ben Arie of Pioneer Group, said he doubted that a rate cut or QE would happen any time soon.

Meanwhile, the central bank lowered its 2015 growth estimate to 3% percent from 3.2% in its last update in March but raised its estimate for 2016 to 3.7% from 3.5%.

It predicted that inflation over the next year ending in the second quarter of 2016 would be 1.6% and that the Bank of Israel interest would remain at its current level until the end of 2015 and increase gradually in 2016.

The Bank of Israel reported on Monday that its index of leading indicators rose 0.3% in May, but revised the index for March and April lower.

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