Bank of Israel Rate Cut Propelled by Unemployment Concerns

Concerns that unemployment may climb outweighed worries about housing prices when the Bank of Israel decided to cut its benchmark rate, a member of the monetary policy committee said.

The Bank of Israel unexpectedly lowered the benchmark interest rate yesterday for the first time in five months, citing lower-than-expected inflation, consumer pessimism, and “disappointing” U.S. economic data.

“We are not yet close to a recession, but we’re moving in that direction,” monetary policy committee member Rafi Melnick said in an interview with Israel Radio today. “There was certainly the concern of unemployment developing.”

With business sector growth underperforming workforce growth, the bank was more concerned about joblessness than high housing prices, which have been fueled by low mortgage rates, Melnick said.

“We are mostly concerned with the development of unemployment in the economy, unemployment that would hurt the entire population, especially young people,” he said in a separate interview with Army Radio. “This causes much greater harm than what is happening in the housing market, we believe.” Steps taken by the bank to limit mortgages have reduced the impact of rate cuts on housing prices, he added.

The January unemployment rate was 5.9 percent, unchanged from the previous month.

Confounded Analysts

The five-member monetary policy panel, led by Governor Karnit Flug, cut borrowing costs by a quarter of a percentage point to 0.75 percent. While rebounding exports in the fourth quarter of 2013 led many analysts to expect borrowing costs would be held, the central bank focused on inflation, which slowed to 1.4 percent in the 12 months through January, and the lower-than-forecast 2.3 percent growth rate.

Five of 24 economists surveyed by Bloomberg forecast the decision, while the remainder predicted no cut.

“In our view, this is very likely to be the last cut in this cycle unless there is a serious decline in inflation and growth from this point,” Daniel Hewitt, a senior emerging market economist at Barclays Plc who was surprised by the decision, said in an e-mailed note. “We expect the BOI to remain on hold over the next year and for the next move to be a hike.”

Record Low

The yield on the government’s benchmark 2023 bond dropped to a record low 3.35 percent at 11:40 a.m. today on the unexpected cut. The shekel was little changed at 3.5166 against the dollar after sliding yesterday as much as 0.5 percent following the decision.

Some traders had bet the central bank would cut. One-year interest rate swaps, an indicator for interest rates over the period, fell by as much 6 basis points in the past 10 days to 0.89 percent, the lowest level in a month.

“It’s a very dovish committee,” said Jonathan Katz, a Jerusalem-based economist at HSBC Holdings Plc. “Their main concern is maybe the same as the ECB’s: deflation. That offset everything else.”

While rebounding exports in the fourth quarter of 2013 led many analysts to expect borrowing costs would be held, the central bank focused on inflation, which slowed to 1.4 percent in the 12 months through January, and the lower-than-forecast 2.3 percent growth rate.

The inflation rate will probably decline again next month to around 1 percent, the lower limit of the government’s 1 percent to 3 percent inflation target band, Katz said.

‘Erosion of Exports’

“The Bank of Israel has taken its head out of the sand and is doing what has to be done,” said Shmuel Ben Arie, head of shekel wealth management at Pioneer Private Wealth Planning in Herzliya. January inflation data “pointed to a decrease in consumer demand and continued economic slowdown,” while economic growth “clearly testified to an erosion of exports and a certain weakness in private consumption,” he said.

Policy makers have gradually cut the rate from 3.25 percent in 2011 in an effort to curb the shekel’s gains and help exports, which account for about a third of Israel’s $273 billion economy. The Bank of Israel has also been buying dollars to weaken the currency, bringing reserves to a record $83.2 billion at the end of January. The currency climbed 7.5 percent against the dollar last year, the most of 31 major currencies tracked by Bloomberg.

The Manufacturers Association of Israel, which had criticized Flug for holding rates steady for four months, welcomed what it said was a “responsible and prudent decision.” The group renewed its demand to cut borrowing costs to 0.25 percent and called for more aggressive foreign currency purchases.

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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