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Israel Rate Swap Declines as Central Bank Holds Borrowing Costs

June 28 (Bloomberg) -- Israel’s two-year interest-rate swaps fell to a three-month low after the central bank left its key borrowing costs unchanged, saying that the shekel’s appreciation and lower commodity prices may dampen inflation.

The cost investors must pay to lock in borrowing costs for two years, a reflection of expectations for the benchmark rate, held at 3.88 percent as of 6:54 p.m. in Tel Aviv, after earlier touching 3.85 percent, the lowest level since March 22, according to data compiled by Bloomberg. The shekel declined 0.1 percent to 3.4454 per dollar.

Bank of Israel Governor Stanley Fischer held the benchmark lending rate at 3.25 percent yesterday after boosting it 10 times in two years. All 24 economists surveyed by Bloomberg forecast the decision. The bank cited slower U.S. economic growth, the worsening of debt risks in Europe, falling commodities prices and gains in the shekel, which has climbed 13 percent against the dollar in the past year.

“The statement was slightly more on the dovish side than seen in previous months,” analysts at BNP Paribas, including led by Paul Mortimer-Lee in London, wrote in a note to clients today. “While it is likely that the bank will continue with its tightening cycle, we think that the current global environment warrants a more gradual approach.”

Stronger Shekel

The currency has strengthened 2.3 percent this year, after rising 7.6 percent in 2010. A stronger shekel helps curb prices of imports while eroding the profit margin for exporters, which account for 45 percent of Israel’s gross domestic product.

Israel’s economic growth slowed to an annualized 4.8 percent in the first quarter from 7.6 percent in the previous period, the fastest pace since 2006. Inflation will fall to 2.9 percent in the next 12 months after accelerating to 4.1 percent in May, according to the average of forecasters surveyed by the Bank of Israel. The government’s target range is 1 percent to 3 percent.

“The shekel appreciated over recent months and there was a decline in commodity prices,” the central bank said. “The impact on inflation of these items is expected to be felt in the future. In light of these issues, and the marked increase of risks in the global economy, it was decided to leave the interest rate at its current level.”

Bernanke Pledge

Commodity prices, as measured by a UBS Bloomberg index, have dropped 6.3 percent since the end of April on signs of slowing global economic growth. Federal Reserve Chairman Ben S Bernanke pledged on June 22 to keep interest rates low for an “extended period” as the U.S. economic recovery has been slower than anticipated. In Europe, policy makers are working on plans to prevent Greece from defaulting on its debt.

The yield on the benchmark Mimshal Shiklit bond due in January 2020 rose two basis points, or 0.02 percentage point, to 5.13 percent. The yields have climbed more than 40 basis points this year as Fischer raised the benchmark rate from a record low of 0.5 percent in August 2009. Economists in the central bank survey on average predict that policy markets will lift the benchmark interest rate to 4.3 percent in a year.

The two-year breakeven rate, which reflects investors’ expectations for annual inflation during the period, declined today by one basis point to 273. The rate, measured by the difference in yields of fix-rated and inflation-linked government bonds, touched 271 basis points on June 23, the lowest level in at least three months.

“Inflation expectations for two or more years have dropped and they are now within the target range,” said Ori Greenfeld, head of the macroeconomics department at Tel Aviv-based Psagot Investment House Ltd.

To contact the reporter on this story: Ye Xie in New York at yxie6@bloomberg.net; Sharon Wrobel in Tel Aviv at swrobel4@bloomberg.net

To contact the editor responsible for this story: Claudia Maedler at cmaedler@bloomberg.net

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