Analysis

Suddenly, Israeli Interest Rates Are Becoming Interesting Again

The Bank of Israel is ready to raise interest rates for first time in over three years: On Monday, officials may signal when that will happen

Karnit Flug, governor of the Bank of Israel, speaks during a Bloomberg Television interview in Jerusalem, Israel, on Wednesday, March 28, 2018
Bloomberg

Perhaps one of the most boring things to occur regularly in Israel over the last few years is the Bank of Israel monetary committee’s decision on interest rates. For 33 times in a row since March 2015, the rate has remained unchanged at 0.1%. Even the committee gave up its monthly rate-setting meetings and now convenes just eight times a year.

That’s all about to change, starting as early as Monday afternoon when the Bank of Israel announces the results of the panel’s latest decision. The time looks increasingly close when the committee will be making its fateful decision to raise rates, or at least signal that a rate hike is imminent.

The financial markets have already readied themselves for a rate rise. Last month the price of government bonds fell (meaning yields rose) and the pace picked up last week.

No one expects the central bank to actually announce a rate rise on Monday. Rather, the markets will be looking for signals in the announcement, as well as from the bank’s revised economic forecast for 2018 and the press conference Bank Governor Karnit Flug will be holding.

In recent years, the role of central bank interest rates has declined. They have been at zero or near zero for so long that they are no longer an effective tool. But central banks do engage in “forward guidance,” i.e., hinting at what they plan to do next on monetary policy.

On target 12-month trailing Israeli inflation

The Bank of Israel has adopted the same policy. Until April 2017, the official outlook on rates had been for month after month that “monetary policy will remain accommodative for a considerable time,” meaning unchanged.

Last April, it was revised to: “The Monetary Committee intends to maintain the accommodative policy as long as necessary in order to entrench the inflation environment within the target range.”

Many forecasters have been saying they expect a rate rise by the end of the year. Bank of Israel economists say they see an increase to 0.25% in the fourth quarter, but that is informed speculation on their part, not an official forecast.

Not counting Monday’s decision, that leaves the monetary committee three more opportunities to act (assuming it doesn’t make an off-scheduled decision, which is extremely rare). The next time will be August 29, then October 8 and finally November 26.

The latter comes two weeks after Flug’s term ends. On Friday, she announced she wouldn’t seek a second term (see story below), but given that the selection process hasn’t begun yet, she might be asked to extend her current term.

Officially, the Bank of Israel is supposed to adjust interest rates to keep inflation within the government’s target range of 1%-3% annually. But that goal is not as simple to achieve at it might seem.

As of May, the month for which the last consumer price index was published, Israeli inflation was running at 0.5% on a 12-month trailing basis. However, the Central Bureau of Statistics will probably report on July 15 that the June CPI reached the 1-3% range.

The reason for the jump is technical. In May 2017, consumer prices dropped a sharp 0.7%, which depressed inflation for the next 11 months. The June 12-month index won’t include that. Without the May 2017 CPI, inflation over the last 11 months was 1.2%, so that even if inflation was a negative 0.1% or 0.2%, it wlil have reached the target range.

However, the monetary committee has a lot of flexibility over how to interpret the inflation data. The 2010 Bank of Israel Law says the bank is only required to use the target as “the basis of the monetary policy,” and in any case must consider “other objectives of the government’s economic policy, especially growth, employment and reducing social gaps.”

In any case, there is more than one kind of inflation apart from the headline consumer price index. Among other things, the committee can decide to ignore the impacts of volatile world energy prices or produce prices, or prices that were raised or lowered by government fiat.

A factor influencing inflation in Israel is the exchange rate. That has been a cause for keeping inflation low in recent years as the shekel strengthened, despite the Bank of Israel’s efforts. However, in the last six months, the dollar has been appreciating against the Israeli currency – up 4.9% so far this year and 1.9% since the Bank of Israel’s last rate decision in May – that, all other things being equal, feeds into higher prices for consumers.

The global situation, meanwhile, also makes it easier for the Bank of Israel to act. The U.S. Federal Reserve raised its benchmark lending rate to 2% from 1.75% in June and has said other hikes are in store. The European Central Bank has said it will stop buying bonds over the course of 2018 under its quantitative easing program.

The only thing that might cause the monetary committee to hesitate is the global trade war U.S. President Donald Trump has set off. While Israeli economic growth was revised upward for the first quarter to 4.5% on an annualized basis and economists have raised their forecast for the year, a global slowdown could change everything.