Almost a year after it raised its base lending rate, the Bank of Israel is expected to reverse course and announce on Monday that it is lowering the rate amid unusually low inflation, mixed data on the economy and a strong shekel.
Among 19 analysts polled by Bloomberg, 11 said they expected the rate to be lowered to 0.1% from 0.25%, reversing the year-old hike. The other eight said they expected no change. A similar poll by Reuters found that 10 out of 16 see a rate cut and the rest forecast no change. The Bank of Israel will announce its decision at 4 P.M. Israel time on Monday.
The central bank’s monetary policy committee had been waiting for the preliminary figures for third-quarter economic growth were released to get a fuller picture of economic trends. The second quarter data were difficult to read because while they pointed to slowing economic activity, the topline figure was pulled down by a sharp drop in vehicle imports ahead of changes in the green tax on cars.
The third-quarter figures came out last Sunday and clarified the trend. Gross domestic product itself grew at a 4.1% annual rate, but underlying the strong figure were mainly one-off factors – a rise in inventories and in public sector spending. The latter came as a surprise even to the treasury, which is responsible for writing the checks on government consumption.
On the balance it was hard to read a single story into the data. As a result, some economists said to wait for more data to come in the next several weeks. If the monetary committee is similarly unsure of what the third-quarter figures mean, it may choose to rely on other numbers, such as the Bank of Israel’s own “S” index.
That index, whose latest update covers the month of September, shows the Israeli economy continuing to grow as a comfortable pace, with no clear signs of a slowdown. On the other hand, economists who are warning of a slowdown can nevertheless, point to weak figures for investment and merchandise exports, for example.
What is more bothersome is the outlook for 2020. Last month the Bank of Israel lowered its outlook for GDP growth to 3% from a previous 3.5% (although affirming a 3.1% rate for 2019). It based its downgrade on the bearish outlook for world trade and on the assumption that the next government will need to adopt austerity policies, including higher taxes that will cut into economic growth.
A new government doesn’t seem likely in the near term, but forecasts for the global economy continue to darken. Last Thursday, the Organization for Economic Cooperation and Development lowered its growth outlook for Israel to 2.9% next year from the 3.2% it had predicted last May. It also cut global growth a more gentle 0.1 percentage point to 2.9%. The OECD’s was the latest in a series of downgrades for the global economy.
The rate rise that occurred last year after the Bank of Israel concluded that inflation had finally risen into the target range of 1-3% annually after four years below it. Four out of five members of the monetary committee supported the increase on the assumption that the odds of inflation falling below the range were low.
In hindsight, they proved to be wrong. Inflation for all of 2018 was just 0.8% and for all of 2019 it is likely to remain under 1%.
In its last rate meeting a month-and-a-half ago, the committee pointed to the appreciation of the shekel since the start of 2019 as reason to believe inflation would trend even lower. In fact, 12-month trailing inflation in October was just 0.4% (0.5% discounting energy and fresh produce prices). Such low inflation justified a rate cut.
The shekel exchange rate is also factoring into the Bank of Israel’s calculations. The main index the monetary committee uses is the nominal effective exchange rate, a weighted basket for foreign currencies. While since the beginning of 2019, the index has dropped 8.9% (meaning the shekel has strengthened), since the last rate decision was taken October 7, the index has barely changed, weakening just 0.1%.
Nevertheless, the most important currency of all is the dollar. Its impact on the Israeli economy, the Bank of Israel believes, is greater than its 26.4% weighting in the basket (which puts it on par with the euro). Since October 7, the dollar has weakened 0.9%, but perhaps more significantly from a symbolic perspective it dropped last week to its lowest against the shekel since March 2018. On Thursday its representative rate was set at 3.46.
If Israel’s base rate is cut on Monday, it will be the first time since February 2015, when it was lowered to 0.1% and stayed there for three years until last November’s increase.
The increase of a year ago was taken during an interim period after Karnit Flug had stepped down as Bank of Israel governor and Amir Yaron has yet to take up the post. Nadine Trajtenberg was serving as the monetary committee chairwoman and the decision was not unanimous.
Likewise, in October’s vote, the committee was divided. The deliberations preceding their decision were lengthy and two of the members voted for a reduction to 0.1% “in order to act now to prevent negative effects later on.” Two voted for no change but said they saw but they noted that “the risks to activity and to inflation are significant, therefore it could be that there will be a need to increase the extent of monetary-policy accommodation in the future.” A fifth supported a rate hike but didn’t vote for one.
In this week’s deliberations, it is reasonable to assume that one of the two who voted no change will vote for a cut.
Among other things, they will have to decide if the world and Israeli economies have changed enough to justify such a move or to continue waiting, for example, due to the growing uncertainty about forming the next government.
At Bank Leumi, economists Gil Bufman and Yaniv Bar said a rate cut is on the horizon but added, “In view of the last consumer price index coming in line with market forecasts and the overall figures for the third-quarter GDP, the Bank of Israel may choose to day the rate cut to early 2020.” Leumi, however, is in a minority on that point.
If the committee does vote to make the cut, it won’t have a lot of room to cut further in the future. It could lower the rate to zero, but the idea of a negative interest rate was rejected by the committee, at least when Flug was governor.
The practical effect of the rate change from 0.25% to 0.1% is pretty small. Its main power is the message it sends. If the monetary committee decides that there is a need for an expansionary policy, there will be a need for complementary policies – buying dollars (increasing the Bank of Israel’s foreign currency reserves, which already sit at $121.4 billion), buying bonds (as it did a decade ago) or perhaps by pulling a few surprises out of its hat.
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