Uncertainty Over Next Central Bank Chief Cloud Israel's Interest Rate Outlook

'We don’t know who the next governor will be and whether there will be a carryover of [Flug’s] stable and dovish approach or will there be someone with different ideas,' Bank Leumi chief economist says

Bank of Israel Governor Karnit Flug sits in her office in Jerusalem during an interview with Reuters in October 2015
\ RONEN ZVULUN/ REUTERS

Bank of Israel Governior Karnit Flug’s decision to step down in November has added to doubts in local financial markets over whether the bank’s dovish policy committee will raise interest rates by the end of 2018.

Even before Flug said she would not serve a second term, after numerous public battles with Finance Minister Moshe Kahlon, markets had been unsure about the bank’s forecast for a 15 basis-point rate rise in the fourth quarter, given low inflation. Her departure makes the picture murkier still: Markets have no idea who will replace her and have already expressed a preference against a couple of mooted candidates.

“There’s uncertainty and worry in the market. We don’t know who the next governor will be and whether there will be a carryover of [Flug’s] stable and dovish approach or will there be someone with different ideas,” Bank Leumi Chief Economist Gil Bufman said. “The closer we get to the date and there is no name out there and no clarity, we will see market jitters.”

Flug took the reins in November 2013 after Stanley Fischer stepped down, and she largely stuck to his policies. The monetary policy committee has left the benchmark interest rate at 0.1% since early 2015, opting not to venture into negative rates, with economic growth moderate and the annual inflation rate below the government’s 1%-3% target for much of that period.

The six-member panel meets again on August 29, October 8 and November 26 — its last gathering of the year. The October meeting will likely be Flug’s last.

While the central bank this month reiterated a projection for a small hike by year-end and another quarter-point move in 2019, market players are less certain since the bank says it wants to see inflation “entrenched” in the target range.

On target 12-month trailing Israeli inflation

Although the annual inflation rate reached 1.3% in June, that was the first time it has topped 1% since 2014.

Minutes of the July 9 meeting showed the committee remained cautious over the pace of inflation gains, saying a premature hike could delay the entrenchment and slow the path of hikes.

Underscoring the market’s doubts, the one-year bond yield stands at 0.2%, while the two-year is at 0.4%.

Some in the market believe inflation is rising and the bank will raise its main rate to 1% by the end of 2019.

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Others expect a slower rate process that will not start until next year, partly to give the shekel time to weaken. A rate hike soon, they believe, would boost the currency and harm exports.

Some are also wondering whether Flug would opt to start the rate-hike process at her last meeting or leave it to her successor or to Deputy Governor Nadine Baudot-Trajtenberg if she becomes interim chief.

“Will Nadine be willing to raise rates?” said Jonathan Katz, chief economist at Leader Capital Markets.

Flug said July 6 she would not seek a second term, although the writing had been on the wall since March, when Kahlon — unhappy with central bank criticism of his housing and tax policies — said he planned to start looking for a new governor.

While Prime Minister Benjamin Netanyahu will appoint the central bank chief, Kahlon’s spokesman said: “They are pretty coordinated on this, but they still have not decided on a name.”

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One market wish is that the position goes to a professional economist and not to Accountant General Rony Hizkiyahu or his predecessor Michal Abadi-Boiangiu, who are also said to be candidates.

“I hope it won’t be a public officer or a political nomination,” said Rami Dror, chief executive of investment house Halman Aldubui. He said the right person must be an independent thinker who is able to confront politicians.

Other names have been rumored. Eugene Kandel and Zvi Eckstein have said they are not interested. Former Governor Jacob Frenkel, a Netanyahu favorite who was forced out of the running in 2013, said he likes his current job as chairman of JP Morgan Chase International.