Rate cut puts brake on shekel rally

The shekel depreciated over 1% against the dollar on Tuesday to NIS 4.23 after Stanley Fischer's unexpected call to cut the interest rate to 4.5% from 5%.

By SHARON WROBEL
December 27, 2006 07:57
3 minute read.
shekels 88

shekels 88. (photo credit: )

 
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Economists and analysts alike welcomed the Bank of Israel's surprising decision to cut the January interest rate by a half a percentage point in an effort to put a brake on the continuing appreciation of the shekel and return the inflation rate into the target range. "It was the right move, though somewhat late," said Shlomo Maoz, chief economist at Excellence Nessuah. "In the preceding two months, the Governor of the Bank of Israel Prof. Stanley Fischer, lowered interest rates by a moderate quarter percentage point each time, but the shekel continued to appreciate." Maoz expects the central bank to cut interest rates down to 4 percent over the next few months as a tool to bring inflation back to the mid-point of the government's inflation target of between 1 and 3% The Bank of Israel said Tuesday it did not expect inflation to return to that range until the second half of 2007. The shekel depreciated over 1% against the dollar on Tuesday to NIS 4.23 after Fischer's unexpected Monday night call to cut the interest rate to 4.5% from 5%. Analysts had been in consensus that Fischer, who had maintained a gradual approach to interest rate cuts, would for the third time lower the benchmark rate by only a quarter percentage point to 4.75%. "Fischer's move was like an electrical shock. I was very surprised, though it was the right move, after the governor propagated a cautious and gradual interest rate policy," said Eytan Admoni, head of foreign exchange at Bank of Jerusalem. It was only in last month's interest rate discussion that the central bank said a negative interest rate differential between the Bank of Israel and the US Federal Reserve demanded a gradual approach, given the possibility of rapid changes in the inflationary environment and the need to avoid shocks in the financial market. With the reduction of the January benchmark rate to 4.5% the local is now 75 basis points below the Fed Funds rate in the US, which stands at 5.25%. "Not long ago, not many would have imagined that a small country and economy like Israel could dare to maintain a lower interest rate than the US, but the market has learned to live with the negative par," said Nir Yafe, manager of Finotec. In recent months, analysts and economists have lamented that the central bank's failure to lower interest rates more drastically had contributed to the shekel's continuing appreciation and the low rate of inflation. Israel's central bank cut its benchmark rate by a quarter-point each in October and November as consumer prices fell in these months, while the shekel rallied to a five-and-a-half year high against the dollar. "The main factor behind these negative changes in the CPI in recent months, is the appreciation of the shekel vis-a-vis the dollar," said Gil Bufman, chief economist at Bank Leumi. "Due to the fall in prices, the inflation environment, based on the trailing 12 month figure, is at a negative figure of 0.3%, which led the central bank cut its interest rate." Bufman added that the next few monthly CPI readings were expected to be negative since the ongoing appreciation of the shekel against the dollar was likely to continue have an impact during the next two to three months. "Any hope of leading the rate of inflation from its currently negative rate back into the price stability range of 1-3%, will be based in the short-term on the depreciation of the shekel," said Bufman. "The acceleration of the pace of rate cuts, seems to have been aimed at spurring depreciation in the exchange rate of the shekel as a means of raising the rate of inflation back into the price stability range."

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