Traders expect Flug to drop interest rate to a new historic low

The strong shekel, however, has cut into Israel's competitiveness on global markets and been a drag on exports, a crucial component of the economy.

By
February 21, 2016 17:21
2 minute read.
Karnit Flug

Karnit Flug . (photo credit: MARC ISRAEL SELLEM/THE JERUSALEM POST)

 
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Bank of Israel Gov. Karnit Flug may cut Israel’s benchmark interest rate, already at a historic low of 0.1 percent, when the bank’s monetary committee announces its monthly interest- rate decision on Monday.

According to Bloomberg, since January, Israeli forward- rate agreement traders have dropped their expectations of interest rates to below the current 0.1% to about 0.05%.

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Flug and the monetary committee last cut the interest rate in February 2015, but several problems have persisted despite its low level.

Inflation, for example, has gone into negative territory, although the central bank has explained that away as a result of one-time shocks. To stimulate inflation, the bank, theoretically, would have to cut rates further.

The shekel also has been stubbornly strong, reaching record levels against a basket of foreign currencies and standing out as one of the few currencies to appreciate against the dollar.

The Bank of Israel has been intervening in foreign-currency markets regularly to offset the shekel’s appreciation, which has been caused in part by the inflow of natural gas from the Tamar field off Haifa.

The strong shekel, however, has cut into Israel’s competitiveness on global markets and been a drag on exports, a crucial component of the economy.



Earlier this month, an analysis by Citibank predicted that the Bank of Israel would drop its rates into negative territory within three months, thereby becoming the sixth central bank to do so after the European Central Bank, Denmark, Sweden, Switzerland and Japan have led the way in recent months.

That traders expect a rate cut Monday is no indication that one will take place, however.

Flug has spoken about her willingness to use unconventional measures, but the bank has reasons to avoid further cuts.

For one, the effect of negative rates remains unclear. For another, the bank has gone out of its way to ascribe the negative inflation to passing events, such as the drop in oil and energy prices and tax cuts Finance Minister Moshe Kahlon has enacted.

Beyond those problems, Israel is concerned with the ever-increasing housing prices.

On Sunday, a report from the Justice Minister’s appraiser found that the price of an average four-room apartment rose 8% in 2015. Lowering interest rates could create a rush toward further investment in assets such as real estate, which could boost prices further.

Ofer Klein, the head of economics and research at Harel Insurance and Finance, told The Jerusalem Post last week that, for now, at least, the Bank of Israel would be better off expanding its foreign exchange interventions than lowering rates.

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