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Israel Rate Nearing Zero Switches Focus to Other Monetary Tools

Bank of Israel Governor Karnit Flug
The shekel weakened and stocks in Tel Aviv climbed after the Monetary Policy Committee, led by Governor Karnit Flug, reduced the rate by a quarter of a percentage point to 0.25 percent. Photographer: Ariel Jerozolimski/Bloomberg

Aug. 26 (Bloomberg) -- Israeli markets are anticipating a switch in monetary policy tools after the Bank of Israel’s latest surprise cut took interest rates close to zero.

The bank, led by Governor Karnit Flug, lowered its benchmark to a record 0.25 percent, seeking to stimulate an economy hurt by the two-month conflict in Gaza and a plunge in exports driven by the shekel’s strength. All 21 economists in a Bloomberg survey had predicted the bank would keep rates unchanged after last month’s unexpected reduction.

“The bank’s interest rate weapon is spent,” said Ilan Artzi, chief investment officer at the Halman-Aldubi Group, based in the Tel Aviv suburb of Ramat Gan. “To encourage future growth, other monetary tools will have to be used, such as buying bonds.”

Israel’s monetary predicament has precedents. Economic turmoil over the past six years encouraged central banks in the U.S. and Europe to test alternative stimulus policies, such as asset purchases, as their benchmark rates neared zero.

In an interview with Army Radio after yesterday’s announcement, Flug said the global crisis has proved that central banks have a variety of options even at near-zero interest rates. “Central banks have things they can do,” she said.

The bank has reduced rates 12 times since August 2011. It also boosted purchases of foreign currency, as the shekel surged almost 13 percent against the dollar in the past two years, the most among 31 major peers tracked by Bloomberg. It bought $1.39 billion in July, the most since January, bringing the total this year to $5.51 billion.

Shekel Plunge

The shekel plunged to the lowest in almost a year after yesterday’s cut, falling 1.1 percent against the dollar. It weakened 0.2 percent to 3.5768 per dollar at 9:04 a.m. today in Tel Aviv.

“The attractiveness of the shekel is zero, as the interest rate today is equal to that of the U.S.,” Shmuel Ben Arie, head of shekel wealth management at Pioneer Private Wealth Planning in Herzliya, said in an e-mailed note.

If the currency rally resumes, though, the Bank of Israel may consider setting a floor for the shekel’s value, according to Rafi Gozlan, chief economist at Israel Brokerage & Investments-IBI Ltd. in Tel Aviv.

‘Inflation Environment’

“If the inflation environment declines further and the shekel stops weakening, the next policy tool the bank will have is setting a shekel floor,” Gozlan wrote in an e-mailed note.

That’s a measure backed by Israeli exporters. Their sales, which account for about a third of the economy, slumped 18 percent in the second quarter. Economic growth slowed to 1.7 percent in the period, down from 2.8 percent in the previous three months.

The Manufacturers Association of Israel has called on the bank to buy enough dollars to keep the exchange rate at 3.8 shekels to the dollar.

The war in Gaza, which has disrupted manufacturing output and tourism, is the main reason behind Flug’s latest cut, said Ofer Klein, head of economics and research at Harel insurance & Financial Services Ltd.

Had it not been for the conflict, which has killed more than 2,100 Palestinians and 60 Israelis, “it would be hard to imagine that the Bank of Israel would have taken such an extreme step, especially at a time when the U.S. is already talking about raising rates,” Klein said in an e-mailed note. “We’re convinced the rate won’t stay this low for long, and when global interest rates start moving upward around the middle of 2015, the rate in Israel will rise, too.”

Alex Zabezhinsky, chief economist at Tel Aviv-based Meitav Dash Investment House Ltd., said the near-zero rate puts the onus for stimulating the economy on the government, which could expand the budget deficit and eliminate some tax breaks.

“With this latest rate cut, the Bank of Israel has exhausted its ability to help the economy,” he said. “The ball is now with the Finance Ministry.”

To contact the reporter on this story: Amy Teibel in N at ateibel@bloomberg.net

To contact the editors responsible for this story: Alaa Shahine at asalha@bloomberg.net Amy Teibel

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