Analysis

After Seven Long Years, Are Israeli Interest Rates Finally About to Rise?

The odds are looking increasingly likely, whether it is on Monday or in November

Governor of the Bank of Israel Karnit Flug, March 28, 2018.
Bloomberg

The last time the Bank of Israel raised interest rates, Stanley Fischer was its governor, Barack Obama was serving his first term as president of the United States and people were using iPhone 4s.

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That was in June 2011. The last time the central bank changed interest rates at all was in March 2015, and in recent years it has stopped holding monthly rate meetings because it was a waste of time to announce 12 times a year that nothing was happening.

But come Monday, the Bank of Israel’s monetary policy committee – the six-member panel that sets interest rates – could be making history by raising rates. It was also be a historic meeting because it will be the last one over which Governor Karnit Flug presides before stepping down next month.

A survey of economists released by Bloomberg on Sunday showed all 10 who responded forecast no change in the rate, now at a record low 0.1%, in Monday’s meeting. The announcement will be released at 4 P.M. local time and if it rises it will be to 0.25%.

Them's the brakes

However, many economists say if not now, the rate will be rising soon.

“The Bank of Israel has more reasons to raise interest rates than not to raise them” said Psagot Investment House’s chief economist, Ori Greenfeld. “Israel’s economic environment is excellent – the labor market is very strong, wages are rising and economic growth is good. It’s not an environment that supports such a low rate.”

Inflation has been rising in recent months and so has the market’s expectations for future inflation, which means that real interest rates – the rate after discounting for inflation – is actually falling, said Greenfield.

After many years under the government’s target, Israeli inflation has finally risen back into the range of 1-3% annually.

Meanwhile, the Bank of Israel itself has signaled that a rate rise is all but inevitable. The bank’s own research department said in its last economic forecast, released in July, that the base rate would be 0.25% by the fourth quarter, which began October 1.

The research department has been wrong before. When the base rate was cut to 0.1% in 2015, the department predicted it would be raised back to 0.25% by the start of the following year. That didn’t happen.

In any case, the research department only relates to the macroeconomic data and whether it points to the need for a rate hike or not. The decision itself lies with the MPC.

But on the level of the MPC, there have also been growing signals that rates were due to rise soon. The minutes express members’ view anonymously, but at the last meeting, August 29, four of the five members, who voted for no change, pointed out that inflation was moving towards “entrenchment” within the target range.

“There is room to begin preparing the markets for the possibility of a measured increase in the interest rate, nonetheless, in order to support the entrenchment, the interest rate should be kept at its current level for now,” the minutes said.

A fifth MPC member wavered, arguing that current rates were not in line with the state of the economy, but voted with the majority to hold them steady since “the possibility for such a step has not yet been internalized by the financial markets,” according to the minutes. A sixth member has been advocating a hike since February.

However, there is a strong possibility that at the next meeting after Monday’s, slated for November 26, the anti-rate hike majority may disappear. Flug will have stepped down two weeks before and as of now no successor has been named, meaning the MPC may have just five members.

Of those, just two – Nadine Baudot-Trajtenberg and Andrew Abir – are Bank of Israel employees. The other three are outsiders – Professors Ruben Gronau, Moshe Hazan and Zvi Hercowitz.

Another reason for raising interest rates is to give the central bank tools to cope with the inevitable next economic downturn. If rates continue at 0.1% the bank will have no choice to cut them to zero or even make them negative, which is a risky strategy. It would rather come into a recession with the option of lowering rates to encourage economic growth from a relatively high level.

“For now everyone is talking about a single rate rise, but I think there’s a good chance we’ll see more than one in 2019 so that the Bank of Israel is adequately armed,” said Greenfeld.

Meanwhile, the United States and Britain have begun raising their rates from record low levels, although the rest of the developed world hasn’t followed suit. The U.S. Federal Reserve has been slowing hiking them since 2015 and last months boosted them a quarter-point to a target range of 2-2.25%.

The fed’s policy is making life easier for the Bank of Israel, but easing the demand for shekels and preventing the Israeli currency from straightening, a phenomenon that threatens to harm exports.

Against a rate rise is the fact that inflation has most recently showed a slight downturn to 1.2% over the 12 months through August. With inflation so close to the bottom end of the target range, the MPC would have to engage in rhetorical acrobatics to declare that inflation is “entrenched” and that raises must rise.

In its last rate decision, the MPC called sharp appreciation of the shekel the thing mostly likely to prevent rising inflation and rising interest rates. In fact, the shekel did strengthen sharply minutes after that decision was released, but now it is almost back to where it was

Meanwhile, falling bond prices around the world and in Israel (see The Ticker on this page) – spurred by the latest Fed rate hike – may cause the Bank of Israel to delay any move. If the Bank of Israel doesn’t act Monday or in November, the rate rise won’t happen till 2019.