Zero Rates Ever Closer in Israel as Traders See Further Flug Cut

  • Forward-rate agreements, interest rate swaps fall below 0.1%
  • Shekel one of two major currencies to climb vs. dollar in 2015

If traders are right, Israel is on the cusp of cutting interest rates to within a whisker of zero.

Shekel forward-rate agreements for the next three, six and nine months, together with one-year interest rate swaps, have all dropped below Israel’s record-low benchmark rate of 0.1 percent, indicating increased bets for a reduction in borrowing costs. That’s something Governor Karnit Flug said policy makers would only enact in “unusual circumstances.”

Seventeen months of falling consumer prices and gains in the shekel that made it one of only two major currencies to appreciate versus the dollar in 2015 are weighing on growth in the country’s export-driven economy. Policy makers from the euro-region to Switzerland to Japan have lowered interest rates below zero in recent months to boost inflation amid a collapse in oil prices.

“The Bank of Israel is running out of options and tools, so the market is pricing in a possibility that the central bank may lower borrowing costs,” said Gil Chen, head of the fixed-income desk at Israel Brokerage & Investments Ltd. in Tel Aviv. “Not this month but possibly in coming months. The pressure on the central bank to act unconventionally will come from abroad with reduced bets of U.S. rate increases this year and more global central banks cutting interest rates to negative territory."


Flug and her predecessor Stanley Fischer reduced the country’s benchmark rate 13 times since 2011, most recently in February last year, aiming to curb shekel gains that make Israeli goods more expensive abroad. Exports account for about a third of the nation’s gross domestic product.

Karnit Flug

Photographer: Ariel Jerozolimski/Bloomberg

“Governor Flug has said in the past that the central bank will act in unconventional situations and use unconventional tools,” said Alex Zabezhinsky, the chief economist at Bnei Brak, Israel-based Meitav Dash Investment House Ltd., the country’s second-biggest money manager. “If you look at what is happening in Japan or Europe, we are already there. The market is pricing in the possibility of a rate cut,” in particular if the global economic situation continues to deteriorate, he said.

Flug doesn’t have to decide yet, according to Yaniv Hevron, the chief economist of Petah Tikva, Israel-based Excellence Nessuah Investment House Ltd., the country’s third-largest investment bank. All 21 economists surveyed by Bloomberg still predict no change to the interest rate when the Bank of Israel meets on Monday.

“The Bank of Israel is in waiting mode, and oil prices will set the agenda in the next three months,” said Hevron. “If oil prices rise, the central bank won’t have to cut further.”

The central bank expects prices to continue dropping in the first quarter of 2016 due to energy price declines and government-initiated price reductions.

Shekel forward-rate agreements, used to speculate on rate moves, for the next three months rose one basis point to 0.065 percent at 9:08 a.m. in Tel Aviv. Contracts for the next six months are trading one basis point higher at 0.08 percent, while nine-month contracts dropped less than one basis point to 0.078 percent. The country’s one-year interest-rate swaps, an indicator of rate bets for the next 12 months, were unchanged at 0.08 percent.

The shekel has appreciated 1.2 percent this month to 3.9114 per dollar.

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