Central bank governor: Global monetary divergence challenging for Israel

Israel was "perceived as an 'emerging markets safe haven,' and appreciation pressures emerged," Bank of Israel governor Prof. Amir Yaron explained.

August 25, 2019 16:21
2 minute read.
Central bank governor: Global monetary divergence challenging for Israel

Amir Yaron speaks during a ceremony whereby he is sworn in as Bank of Israel governor by Israel's President Reuven Rivlin, in the presence of Prime Minister Benjamin Netanyahu and Finance Minister Moshe Kahlon, in Jerusalem. (photo credit: REUTERS)

The divergence in economic developments among leading economies is especially challenging for Israel and other small economies with major trading partners across separate blocks, according to Bank of Israel governor Prof. Amir Yaron.

Addressing the Federal Reserve Bank’s Jackson Hole Economic Policy Symposium, Yaron highlighted that approximately one-quarter of Israel’s trade in goods and services is with the United States and about one-third is with Europe.

“Naturally, divergent monetary policy, as witnessed in the last few years had important implications for independent monetary policy,” said Yaron.

“The Fed’s policy, to gradually but persistently raise interest rates during the last three years, while the ECB and the BOJ retained – even enhanced – their accommodative stance, placed some central banks of SOEs [state-owned enterprises] in a dilemma.”

While it was perceived in Israel during the 1990s and early 2000s that central bank interest rates must be significantly higher than the United States to prevent capital outflows followed by depreciation and inflation, Yaron said recent US rate hikes and low Israeli rates led to capital inflows – a “marked change” from previous patterns.

Israel was “perceived as an ‘emerging markets safe haven,’ and appreciation pressures emerged,” Yaron explained.

Highlighting recent analyses by the Bank of Israel, Yaron highlighted challenges posed by the divergence of policies in major economic blocks. Until the global financial crisis of 2007-2008, yields in the US and Europe were “highly correlated,” so there was no need to distinguish between their effects on Israeli government bond yields.

Since the crisis, however, Yaron stated that Israeli yields have become strongly correlated with the European ones and hardly correlated with US yields, despite similar trade magnitudes and the resemblance of Israel’s growth and unemployment rates with the United States.

“One can immediately observe how Israel is caught in between,” said Yaron. For short maturities, Israel is closer to the European block. Longer maturities, in particular the 10-year rate, Israel is closer to the United States.

On Wednesday, the Bank of Israel’s monetary committee will announce its latest decision regarding Israel’s benchmark interest rate, which currently stands at 0.25%.

While economists in the central bank’s research department previously forecast that the interest rate could be increased again at the end of the third quarter of 2019, Yaron issued a rare statement in July – amid drastic appreciation of the Israeli shekel and the Fed’s decision to lower its benchmark rate – that a further hike would be unlikely “for a long time.”

Faced with decreasing rates of inflation, below the Bank of Israel’s target range, Yaron emphasized the need for central bankers – especially in SOEs – to be patient and risk averse prior to committing to new policy rules.

“Between 2009 and 2013, Israel’s inflation rate was higher than in other OECD countries, yet subsequently the picture turned around and by 2017 the cumulative price increase since 2009 was similar,” said Yaron.

“Such developments make real-time assessments of whether policy-makers are faced with transitory divergence or structural economic changes a challenge. More generally, while there is a wish to not be behind the curve, the uncertainty and ambiguity suggest a call for greater patience and risk aversion.

“It is this fine line that central bankers face when transforming data analysis into policy. It highlights the difficulty of balancing data dependency with a clear policy rule and its communication, especially for SOEs who also have to take into account the policy rules of others.”

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