Gaza Conflict Tips Flug in Cutting Interest Rate to 0.5%

Israel’s central bank, led by Governor Karnit Flug, unexpectedly cut the benchmark interest rate today on concern that the army’s offensive against militants in the Hamas-led Gaza Strip may hurt economic growth.

“It is still too early to tell the economic effects of the security situation, but the effect of security events of similar magnitude in the past decade turned out to be a moderate macroeconomic impact, up to about 0.5 percent of GDP,” the central bank said in its statement announcing the rate decision.

While 18 of 21 economists surveyed by Bloomberg expected the Bank of Israel to keep its benchmark rate at 0.75 percent for a fifth time, Rafael Gozlan said the Gaza conflict tipped the balance toward trimming the borrowing cost.

“You can’t completely ignore the effect of the security incidents,” Gozlan, chief economist at Israel Brokerage & Investments Ltd. in Tel Aviv, said before the decision. “They come at a time when there is weakness in consumption and inflation, and therefore could push these down still further.”

The Bank of Israel forecast growth would slow to 2.9 percent this year from 3.3 percent in 2013, while inflation is expected to slow to 0.4 percent, according to its quarterly forecast June 23. The upsurge of violence since July 8 will moderate growth in the third quarter as tourism and consumer spending decline, Bank Leumi Le-Israel Ltd. said in an e-mailed note July 24.

Swaps Tumble

One-year interest rate swaps, an indicator of traders’ rate expectations in the period, tumbled 6 basis points to 0.54 percent at 4:23 p.m. in Tel Aviv. The yield on Israel’s benchmark bond due March 2024 fell 3 basis points to 2.69 percent. Israel’s currency was little changed, trading at 3.43 per dollar.

Israel, which had reduced the scope of its operations today, this evening issued a warning for residents to evacuate some parts of Gaza. About 1,050 Palestinians, 45 Israelis and a Thai worker in Israel have been killed in the fighting.

While the majority of economists surveyed by Bloomberg didn’t predict a rate cut today, some did expect the Bank of Israel to reduce it eventually.

“With battles raging in Gaza, the MPC decision comes at a very uncertain time for the economy,” Daniel Hewitt, a senior emerging-markets economist at Barclays Plc, said in an e-mailed note. “We do expect the Bank of Israel to contribute to the recovery.”

Markets Indifferent

Israeli financial markets have been mostly unaffected by the escalation in violence, with the benchmark stock index gaining since it began and yields on Israel’s benchmark 10-year near a record low.

The pace of Israeli growth has declined “in recent years” to an annual average of 3 percent, from 4.5 percent in 1990-2010, as exports suffer due to the slow recovery of world trade, the Finance Ministry said July 6. The Manufacturers Association of Israel has called on Flug and her committee to cut the base rate to zero and to “drastically” step up foreign currency purchases.

The Bank of Israel has cut the benchmark rate 10 times in the past four years, including a surprise reduction last September, the first after Flug took over from former Governor Stanley Fischer, now vice chairman at the U.S Federal Reserve. Gozlan was the only economist of 18 polled by Bloomberg to predict that move.

This time, Gozlan wasn’t alone in forecasting that the monetary policy committee would cut the borrowing cost. Yair Drori, Tel Aviv-based chief economist at Tafnit Discount Asset Management Ltd., and David Lubin of Citigroup Global Markets Ltd. in London also predicted a cut.

Figures for private consumption, retail sales, manufacturing and exports “weren’t good” even before the deterioration in the security situation, Drori said by phone.

“If you take into account that it is clear that consumer spending will be hurt, and that production in factories in the south has been affected, there is definitely room for easing,” he said.

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