Israel Seen Preparing More Shocks for Shekel After Surprise Cut

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Bank of Israel Governor Karnit Flug isn’t finished driving down the shekel after her surprise interest-rate reduction on Monday.

The Israeli currency plunged the most in a month to 3.914 per dollar in New York on Monday after Flug cut Israel’s benchmark rate to a record low 0.1 percent, surprising 20 out of 23 economists. The moves were designed to help reverse a five-month-long slide in consumer prices that has sparked concern that deflation may be seeping into the economy.

With interest-rate cuts almost exhausted, Flug may step up intervention in foreign-exchange markets or begin buying bonds through so-called quantitative easing to spur lower interest rates, economists said. Israel’s cut was the latest in a series of central bank surprises from Switzerland to Australia as policy makers try to ward off deflation and weaken their currencies to fuel export-driven economic growth.

“We are in the middle of a global currency war in which Israel cannot allow itself to lose its global competitiveness,” Shlomo Maoz, chief economist at S.M. Tel Aviv Investments Ltd. who was one of the three to correctly forecast a rate cut, said by telephone. “The Bank of Israel will not allow an appreciation of the shekel until the world economy will rebalance, hopefully in 2016, once the U.S. economy will draw the world economy higher.”

While the shekel weakened by about 9 percent against a basket of currencies between July and December, it has recouped some of those losses since then. The currency slid 1.4 percent against the dollar Monday, the third-biggest decline among 31 major currencies. It depreciated 1.1 percent to 3.9546 at 4:15 p.m. in Tel Aviv on Tuesday.

13 Cuts

Israel’s central bank has reduced rates 13 times since 2011 in a bid to help boost growth. It has also bought foreign currency to weaken the shekel and make exports more competitive.

“The BOI was concerned that if it would not now join the global wave of monetary expansion, the appreciation of the shekel would continue,” Modi Shafrir, chief strategist of the Finance Division of Mizrahi-Tefahot in Ramat Gan, Israel, wrote in a Feb. 23 note to clients after the cut was announced. “We do not rule out a situation where the BOI will also increase its purchases in the foreign-exchange market in the coming months.”

The Bank of Israel has signaled that it’s ready to follow the U.S. Federal Reserve and European Central Bank in using other instruments to stimulate the economy.

It said Monday that it will “examine the need to use various tools to achieve its objectives,” echoing comments made in December when it said “unconventional tools” may be required.

Weak Growth

Israel’s expansion of 2.9 percent was the weakest since 2009, and the country has experienced several months of deflation, with consumer prices falling 0.5 percent in the 12 months through January. The bank said its latest cut aims to return inflation rate to its 1 percent to 3 percent target range within a year “and to support growth while maintaining financial stability.”

Flug’s drive to weaken the shekel and lower borrowing costs may be limited by the risk of fueling asset bubbles, said Alex Zabezhinsky, chief economist at Tel Aviv-based Meitav Dash Investment House Ltd.

“The Bank of Israel is acting in a very extraordinary way to weaken the shekel,” he said by phone. “This can be very dangerous because it will continue to fuel a housing market increase after the market has already risen so much.”

Under former governor Stanley Fischer, the Bank of Israel used monetary tools such as purchasing foreign currency and buying government bonds in 2009 to help the economy recover from the financial crisis. While it’s unclear what path Flug will take this time around, the central bank needs a weaker shekel in order to normalize monetary policy, said Daniel Tenengauzer, head of emerging-market and global foreign-exchange strategy at RBC Capital Markets in New York.

“This is the most out-of-the-box central bank in emerging markets,” he said in a telephone interview. “They are not gradual. They are very proactive. They could potentially do anything.”