Israel's Central Bank Holds Rates Unchanged, Cuts Growth Outlook

Governor Karnit Flug signals she won’t surrender to pressure from the finance minister to raise rates to cool the housing market.

Michal Fattal

Resisting pressure from Finance Minister Moshe Kahlon, the Bank of Israel said Monday it was keeping its key lending rate unchanged for January and forecast slower economic growth for this year and next.

Kahlon has been pushing the central bank to raise rates as a way of cooling off Israel’s overheated housing market by discouraging mortgage borrowing. But Governor Karnit Flug insisted at a press conference that the bank would not be influenced by issues outside its mandate.

“Monetary policy is determined by the Bank of Israel Law and is intended to influence inflation and economic activity. Just like other central banks, the Bank of Israel’s decisions are made independently and we act in line with the mandate we were given under the law,” she said, adding that the bank was “keeping rates low and they will remain so for some time.”

The base lending rate will remain 0.1% in January for a 10th straight month, the rate’s lowest level ever. All 14 economists polled by Reuters had forecast no change by the Bank of Israel following recent data showing moderate economic growth and nonexistent inflation.

Meanwhile, the central bank’s economists lowered their estimate for 2015 gross domestic product growth to 2.4 % from their 3% forecast made in September. They said growth would pick up in 2016 to 2.8%, but their previous estimate was 3.3 %. In 2017, the bank said growth would accelerate to 3.1% on stronger exports and investment in fixed assets.

Despite the weaker economic outlook, Flug said a rate reduction wasn’t necessary. “We can use unconventional tools like negative interest rates, but they’re only appropriate in unusual circumstances, and we’re not there,” she said. “We’re forecasting a reasonable rate of economic growth even if it’s low.”

The central bank said it expected consumer prices to fall 0.8% in 2015 and climb 0.6% next year. Still, inflation won’t fall inside the government’s annual target range of 1% to 3% until 2017, when 1.6% is predicted.

But Flug said the inflation outlook also didn’t justify a rate reduction. “Low inflation is due mainly to one-time factors and energy prices,” she said. “None of these justify reducing interest rates to negative territory.”

The bank estimates that the key rate will stay at 0.1% for the first three quarters of 2016 and start rising in the fourth quarter to end the year at 0.25%. It would then increase to 1% by the end of 2017.

Jonathan Katz, chief economist at Leader Capital Markets, said the Bank of Israel’s more bearish outlook for the economy suggested that rates would not be rising anytime soon. “It’s a clear message to the market that rates won’t be rising in the next few months, despite the pressure from the finance minister,” he said.

Ilan Artzi, head of investments said Halman-Aldubi, said the central bank had failed to understand that interest rates no longer had the power to influence the economy as they had in the past. But he said increased consumer spending and falling unemployment showed that rates need not come down further.

Artzi said the U.S. Federal Reserve’s decision to raise interest rates this month for the first time in nearly a decade would give the Bank of Israel more freedom of action, since it could now expect the rate differential with Israel to support a weaker shekel and help Israeli exports.