Bank of Israel Unexpectedly Cuts Lending Rate

Israel’s central bank unexpectedly cut its benchmark interest rate to a three-year low and announced a program to purchase foreign currency to limit gains in the shekel. Israeli stocks and bonds rose.

The Bank of Israel, led by Governor Stanley Fischer, lowered the lending rate by a quarter of a percentage point to 1.5 percent, sending the shekel down the most since January. The bank said the steps were “in light of the continued appreciation of the shekel, taking into account the start of natural gas production from the Tamar gas field, interest rate reductions by many central banks --- notably the European Central Bank, the quantitative easing in major economies worldwide and the downward revision in global growth forecasts.”

The bank started buying dollars in April for the first time in almost two years as the start of natural gas production off Israel’s coast and interest rates more than double the level of the U.S., U.K. and Japan lured inflows. Fischer said last month that rates higher than those in major economies are encouraging inflows of short-term investment, sparking speculation that he may lower borrowing costs.

Central banks overseeing about a quarter of the world’s gross domestic product have cut interest rates this month, spanning the globe from the euro area and Australia to Kenya and Sri Lanka. Exports make up about 40 percent of Israel’s economy and are hurt by a stronger shekel, which has surged 8.9 percent in the past six months, making it the second-best performer after the Mexican peso among 31 major currencies tracked by Bloomberg.

‘More Impact’

“We were expecting a rate cut at the next scheduled decision because of low inflation, the rate cuts being made abroad and the capital inflows due to the rate differential,” said Ayelet Nir, chief economist and strategist at Psagot Investment House Ltd. “Doing it as a surprise move gives it more impact, while the downside is it gives the appearance of acting under pressure.”

The central bank move came a little more than a month before Fischer plans to step down. The 69-year-old governor, a former No. 2 at the International Monetary Fund, said he was leaving for personal reasons, mostly because his family is in the U.S. and he has achieved many of the goals he wanted to accomplish.

‘No Choice’

Tal Zohar Avda, chief executive officer of the Forex Capital Markets LLC, said the rate cut was “one of the last things Fischer would have wanted to do, because he wanted to avoid reducing rates to avoid fueling the real estate market.”

Given that the bank’s last interventions failed to achieve the goal of weakening the shekel, “he had no choice,” Avda said.

The bank said today it will purchase about $2.1 billion by the end of the year, to help offset the effects of natural gas sales. It will revisit the plan when a natural gas “wealth fund” begins operation, which is due in 2018.

“Natural gas production in Israel is causing an improvement in the current account, which is leading to appreciation pressures on the shekel,” the bank said in a statement. “This phenomenon, often referred to as ‘Dutch disease,’ is liable to negatively impact Israel’s economy.”

More rate cuts may be necessary within the next four months depending on how the shekel performs, Tevfik Aksoy, chief economist for central and eastern Europe, the Middle East and Africa at Morgan Stanley in London, wrote in an e-mailed note to investors.

‘Testing Waters’

“Essentially, the Bank of Israel will be testing the waters with regular purchases and, in case the appreciation pressures escalate again, it will actively pursue an intervention policy, in our view,” Aksoy said.

The shekel weakened the most since January after the decision, falling 0.9 percent to 3.6027 per dollar at 5:18 p.m. in Tel Aviv. The benchmark TA-25 stock index closed up 1 percent to 1,204.66, its biggest gain since Feb. 20. The yield on the 4.25 percent government bonds due March 2023 fell three basis points to 3.51 percent.

“This is a wrong move,” Gilad Alper, a senior analyst at Excellence Nessuah Brokerage Ltd., said today by phone. “It will blow more air into the real estate bubble, push toward excessive risk taking and hurt the purchasing power of Israelis by making imports more expensive.”

The Bank of Israel monetary policy committee said in an April 7 statement that the rate of increase in home prices remained high in recent months, with no sign of a slowdown.

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