The Bank of Israel expects domestic interest rates to remain low for some time to come and they may even turn negative, Governor Karnit Flug said on Monday, signaling that the central bank had no plans to shift policy after the U.S. Federal Reserve raised its rate last week.
“For now, it doesn’t look like that will change the trend [in Israel] dramatically,” Flug told the Knesset Finance Committee.
Her remarks extended the rift she has with Finance Minister Moshe Kahlon, who has signaled he would like interest rates to rise to help stem the increase in home prices. Low interest rates reduce the cost of borrowing for people taking out mortgages, encouraging them to buy homes.
Flug said she was concerned about housing prices and the growing rate of mortgage borrowing, warning that they constitute a risk to the stability of the financial system in the event that home prices dropped suddenly or the economy were to slip into a recession.
But Flug said Israeli monetary policy would have to remain accommodative for an extended period. She pointed to the global monetary environment where base lending rates are close to zero and the European Central Bank is undertaking an expansive monetary policy, in contrast to the U.S. Fed.
Meanwhile at home, Flug noted, the consumer price index had declined 0.9% in the 12 months through November. Inflation expectations for the next two years, as imputed by the differential between inflation-linked and unlinked bonds, see inflation of just 0.7%, below the government’s official target range of 1-3%.
“We need to recall the global zero interest rate environment and then to guess what would be the employment situation and where we would be vis a vis inflation, if interest rates were disconnected from their surroundings,” she told lawmakers. “We can assume that there would be a big appreciation of the shekel.”
The Bank of Israel cut its key rate last February to a record low of 0.1%. Flug said if the bank raised rates, it risked strengthening the shekel and hurting exports and economic growth.
Israeli economic growth has, in fact, been tepid most of this year, but Flug sought on Monday to put it in context, saying it was largely due to a prolonged strike at Israel Chemicals, declining tourism and a strong shekel along with slow global trade growth.
Israeli gross domestic product grew at 2.5% annualized rate in the third quarter after a 0.2% rise in the second. But Flug noted that Israel had made strides in bringing more people into the workforce, with the labor force participation rate now at 80% for people in their prime working age. Unemployment remains a low 5.3%, she noted.
Flug noted that Israel continued to have a high poverty rate compared to other countries belonging to the Organization for Economic Cooperation and Development, but she noted that the growing labor force participation rate was helping to alleviate the problem. Among families with no breadwinner, the poverty rate last year was 68%, but fell to 25.4% if there was one breadwinner and just 5.6% if there were two.
Regarding the Strom committee interim recommendations on increasing competition in consumer lending, Flug said she opposed forcing the two medium-sized banks – Israel Discount and First International – to divest their CAL credit card joint venture. The panel recommended that the two biggest lenders – Bank Hapolaim and Bank Leumi – sell their credit card subsidiaires, which Flug said he backed.
“A complete exit of the banks from the market will weaken competition,” she explained. “My opposition to separating Cal from the banks aims to strengthen the medium-sized banks against the two bank lenders.”
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