Palestinian Attacks May Compel Bank of Israel to Slice Base Rate

  • Climate of fear from violence expected to hurt economic growth
  • Flug may have to cut after holding rate Monday at record low

Economic fallout from a surge in Palestinian attacks on Israelis could compel Bank of Israel Governor Karnit Flug to cut the base interest rate beyond its record low, analysts say.

The central bank held the rate at 0.1 percent for an eighth month on Monday, saying “monetary policy will remain accommodative for a considerable time.” Addressing the bloodshed, it said that “past experience shows that the wave of violence may have an impact on private consumption and on tourism, but if it does not last long, the effect is expected to be moderate.”

During Israel’s military conflict in Hamas-ruled Gaza last summer, the bank twice reduced the rate, said Alex Zabezhinsky, chief economist at Meitav Dash Investment House Ltd., the country’s second-largest investment house, based in Bnei Brak. “If the security situation continues as it is, and people are afraid to go out to shop or entertain themselves, this will become an issue in coming rate decisions.”

Palestinian stabbing, shooting and stoning attacks in October have led to the death of 10 Israelis and more than 50 Palestinians, most of them attackers. The unpredictable nature of the violence has generated fear even in a country accustomed to militant groups’ bombings and rocket fire.

Private Consumption

The damage to private consumption and tourism “may invite a rate cut and continued expansionary policy” by the Bank of Israel, Excellence Nessuah Investment House Ltd. said in an Oct. 27 note. The Petach Tikvah, Israel-based firm last week advised investors to transfer “a substantial part of their portfolios abroad” as a defensive move against the impact of the security situation.

Israeli benchmark bonds due 2025 gained on expectations Flug is open to resuming rate cuts, pushing yields to the lowest since May. Shekel forward-rate agreements, used to speculate on rate moves for the next three months, are trading six basis points below the central bank base rate of 0.1 percent, indicating that investors expect more monetary easing.

Israeli economic growth was already slowing before the violence erupted in October, with the Finance Ministry cutting its forecast to 2.6 percent this year and 2.9 percent next year, down from previous projections of 3.1 percent and 3.3 percent.

Shekel Appreciation

Despite the eruption of violence, the shekel appreciated 1.5 percent this month against a basket of currencies, including the dollar and the euro, and is headed for the best monthly gain since July. Some investors speculate that the violence will be temporary and won’t have a significant impact on economic growth.

“The shekel remains very strong in trade-weighted terms,” dragging down exports, and the “growing geopolitical tensions may also weigh on economic activity, through lower tourism and weaker consumer confidence,” Goldman Sachs analyst Kasper Lund-Jensen said this week by e-mail.

Bank Hapoalim’s Purchasing Managers Index, which measures industrial activity and indicated a manufacturing slowdown in September, cautioned on Oct. 18 that the figure for this month “is likely to be affected by the security situation.”

A main factor weighing against a rate cut in the coming months is the rise in home prices spurred in part by low borrowing costs. The central bank’s monetary policy has been criticized for contributing to a housing bubble, and it pointed out in this week’s rate decision that prices have risen by 6.2 percent over the past 12 months, and “the volume of new mortgages remains high.”

With the rate already near zero, Flug may not be eager to cut below zero, Meitav-Dash’s Zabezhinsky said in a phone interview. “It’s possible the bank will drag out delaying a rate cut for another month, but in my view, at the end of the day it will have to cut, because we are heading into a period of lower economic growth, in part because of the security situation.”

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