Bank of Israel Chief: Currency War Taking Irreversible Toll on Business

Remarks come as the central bank cuts its growth outlook for this year, but Karnit Flug says Brexit is likely to have a minimal economic impact.

Moti Bassok
Moti Bassok
Bank of Israel Governor Karnit Flug holds up a newly designed 50 shekel banknote. September 10, 2014.
Bank of Israel Governor Karnit Flug holds up a newly designed 50 shekel banknote. September 10, 2014. Credit: Reuters
Moti Bassok
Moti Bassok

Bank of Israel Governor Karnit Flug warned Monday that a global currency war was threatening the existence of many Israeli businesses but said the central bank would keep to its policy of intervening in the currency market rather than lowering interest rates.

“Most central banks around the world are adopting very accommodative monetary policies that are acting, among other things, to weaken their currencies, and these measures are creating distortions in the global exchange-rate system,” Flug told a press conference.

“This situation may lead to an erosion of profitability among many businesses in Israel to an extent that will not allow them to survive this period . When foreign exchange markets return to equilibrium, it’s likely that these businesses will not reopen.”

Her remarks came as Bank of Israel economists slashed their growth outlook for the Israeli economy. But Flug said Israel was well positioned to weather the impact of Britain’s vote to leave the European Union, despite the current gyrations.

Citing tepid first-quarter growth in a revised forecast Monday, the Bank of Israel said gross domestic product would grow just 2.4% this year, about the same as in 2015 but down sharply from its 2.8% projection at the end of March.

Central bank economists said they expected growth to pick up in 2017 but only to 2.9% – and that figure was cut slightly from a previous projection of 3%.

At the same time, consumer spending should stay robust but ease in the second half of 2016, it said.

Israel’s annual inflation rate, currently a negative 0.8%, is forecast to reach 1% in a year’s time, which would put it inside the annual target of 1% to 3% for the first time in a long time. Israel has been in a deflationary trend for 21 months.

Despite the currency wars and the risk to Israeli businesses, Flug indicated that domestic conditions – in particular soaring home prices – precluded interest rate cuts. Instead, the central bank would continue to intervene in the currency market to prevent an appreciation of the shekel.

On Monday, the Bank of Israel left its based lending rate at a record low 0.1% for a 16th straight month. Meanwhile, the dollar strengthened to 3.90 shekels, the first time it has reached that level since mid-March. But the euro continued to sink, losing more than 0.6% to 4.2912 while the pound tumbled 3.5% to 5.1531.

Flug said uncertainty over the impact of Britain’s Brexit vote meant monetary policy might have to stay accommodative for a considerable time. Financial markets remain volatile and it is still difficult to know what the short-term effects will be on markets.

“We have again seen an illustration that the environment in which policy operates both in Israel and around the world does not cease to surprise or provide dramatic developments that pose complex challenges and dilemmas to policy makers,” Flug said.

While some central banks have said they are ready to provide resources to the banking system and open foreign currency liquidity among central banks, Flug said Israel did not need such measures.

She cited estimates from the International Monetary Fund that unless a Brexit undermines the structure of the entire European Union, it will do no more than shave 0.1% to 0.3% off world economic growth this year.

In any case, the Israeli economy is prepared to cope with any fallout, she said reiterating remarks by Prime Minister Benjamin Netanyahu and Finance Minister Moshe Kahlon the day before.

Besides a strong banking system, “the strength of the Israeli economy is also reflected in the macroeconomic variables such as low public debt levels, high foreign currency reserve levels, a current account surplus and a robust labor market,” she said.

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