Israeli Bonds, Shekel Jump After Central Bank Chief Says Next Interest Rate Move Would Be a Hike

After holding the benchmark rate at 0.1 percent for a fourth straight month, Bank of Israel Governor Flug says the central bank was less likely to use unconventional monetary tools in the near term.

Emil Salman

REUTERS - Israeli bond yields jumped and the shekel strengthened on Tuesday after comments by the head of the central bank suggested a monetary easing cycle that began in 2011 was over and the next interest rate move would be a hike.

After holding the benchmark rate at 0.1 percent for a fourth straight month on Monday, Bank of Israel Governor Karnit Flug said the central bank was less likely to use unconventional monetary tools in the near term, since the inflation outlook had improved while the economy was growing moderately.

While rates were expected to stay unchanged, market players had priced in one more cut to zero and Flug herself had said in recent months she was ready to take stronger action if needed, with a possibility of negative rates or quantitative easing.

"They are no longer thinking that," said Barclays economist Daniel Hewitt. "There will be a long period of quiet and (wondering) when they will raise rates."

"It's still data-dependent but (Flug) clearly is thinking (the easing cycle) is over," Hewitt said. "She is trying to make it to the point where the (U.S.) Fed starts raising rates and then it will be easier for (Israel's central bank)."

Bonds sold off across the curve, with yields up as much as 24 basis points. The shekel rose 1.3 percent against the dollar to an eight-month high of 3.78, from Monday's fixing of 3.833.

Most of the shekel's move came late on Monday when Flug's comments - deemed hawkish by many analysts - triggered stops at the 3.80 level, dealers said.

Ofer Klein, head of economics and research at Harel Insurance and Finance, said the comments may have come off stronger than Flug intended, so the bank was likely to respond with "continued foreign exchange purchases and more dovish statements in the future."

According to Bank of Israel economists, the key rate will stay on hold through 2015 and gradually start to rise in 2016.

Currency broker FXCM Israel said the next technical level for dollar-shekel was 3.73.

Flug also said the shekel was a bit overvalued, so in the absence of further rate cuts, the central bank will likely have to remain active in the market. Over the last three months, the bank bought $2 billion of foreign currency to prevent the shekel from gaining rapidly and harming exports.

However, Goldman Sachs economist Kasper Lund-Jensen said the market over-reacted to Flug's remarks and kept his call for a cut to zero rates in the second half of the year.

The Bank of Israel has cut its key rate 13 times since late 2011 from a high of 3.25 percent.