Flug Seen Pausing on Rates Before Possible Cut: Israel Markets

Karnit Flug will probably wait before lowering Israel’s benchmark interest rate again to weaken the shekel, leaving borrowing costs unchanged today in her first meeting as central bank chief, a survey of economist showed.

While 22 out of 24 economists surveyed by Bloomberg expect the Flug-led monetary policy committee to keep the lending rate at 1 percent, interest rate swaps signal that some investors aren’t ruling out another cut. That will probably happen later this quarter, said Daniel Hewitt, an economist at Barclays Plc in London and the most accurate forecaster of the Bank of Israel’s rate decisions according to data compiled by Bloomberg.

“The basis for further cuts is forming,” Hewitt said in an Oct. 25 note to clients. “High-tech exports have been falling, raising concerns that shekel appreciation may be harming the competitiveness of Israeli goods.”

Finance Minister Yair Lapid said Oct. 24 the government will work with Flug, whose appointment the cabinet approved yesterday, to weaken the shekel, which he said was “too strong.” The Bank of Israel has lowered the key rate from 3.25 percent in 2011, including a surprise rate cut last month, and bought $835 million in September to curb the currency and bolster the country’s export-driven economy. The shekel has gained almost 10 percent in the past year.

Little Latitude

One-year interest rate swaps, an indicator of investor expectations for rates over the period, declined to 0.92 percent on Oct. 25, below the current benchmark. One-year Makam bills, one of the instruments sensitive to expected changes in interest rates, declined to 0.87 percent on Oct. 24.

Under Stanley Fischer, Flug’s predecessor, the Bank of Israel suprised economists in about a quarter of its rate decisions, more often than any other Organization for Cooperation and Development country for which comparable data is tracked by Bloomberg. Flug said in June that Fischer taught her much of what she knows about conducting monetary policy.

With inflation at 1.3 percent, within the 1 percent to 3 percent target range, the central bank has room to lower borrowing costs further. The risk is that a cut will fuel housing prices, which have surged 70 percent since 2007.

Rafael Gozlan, the only economist surveyed who correctly predicted the Bank of Israel’s rate cut last month, says investor expectations for an additional rate cut may be “overly aggressive.”

“We expect the interest rate to remain unchanged in the coming months,” Gozlan said. “For another move, there would have to be a significant worsening in the global picture.”

Split Vote

The split vote on last month’s cut makes another reduction this month less likely, said Alex Zabezhinsky of Tel Aviv-based Meitav DS Investment House Ltd. Since the start of the current loosening cycle, in 2011, the bank hasn’t made consecutive rate cuts, with the exception of two decisions this May, he said.

Economists at Germany’s Commerzbank and Tachlit Discount Portfolio Management in Tel Aviv were the only two to predict a rate cut today. Commerzbank cited the shekel appreciation and the lack of inflation pressures as the reasons for the reduction.

For now, the Bank of Israel will probably pursue a mix of policy actions to deal with shekel appreciation, Hewitt said, including further foreign currency intervention and regulatory changes. In the meantime, Lapid’s statement indicates the ministry may be working on a joint strategy with the Bank of Israel to limit the shekel appreciation, he said.

Easing Burden

“The Bank of Israel apparently is relying more on the government to take some of the burden of combating shekel appreciation,” he said.

The shekel’s 9.8-percent rise in the past 12 months has made it the best performer among the 31 major global currencies Bloomberg tracks. Exports, excluding diamonds and start-ups, will probably shrink by 1.1 percent this year, according to a Bank of Israel September forecast.

The bank expects economic growth to slow to 3.4 percent in 2014 from 3.6 percent this year, though Lapid said last week it could grow as much as 4 percent.

Flug met with Lapid yesterday for their first working meeting since her appointment, the Finance Ministry said in an e-mailed statement. Lapid said the meeting underscored the necessity of cooperation between the two to deal with the economy’s challenges.

To contact the reporter on this story: Alisa Odenheimer in Jerusalem at aodenheimer@bloomberg.net

To contact the editor responsible for this story: Andrew J. Barden at barden@bloomberg.net

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