Israeli Shekel Pares Drop as Borrowing Costs Held at Record Low

  • Third-best performer in past year among major currencies
  • One-year interest rate swaps signal no change in lending costs

Israel’s shekel strengthened, paring earlier declines, after the Bank of Israel kept interest rates on hold for the 13th straight month amid expectations for higher inflation.

The currency rose 0.2 percent to 3.831 per dollar at 5:31 p.m. in Tel Aviv after earlier weakening as much as 0.3 percent. Government bonds rose and the TA-25 Index was unchanged. Policy makers left the base lending rate at a record low of 0.1 percent, as predicted by all 21 analysts in a Bloomberg survey.

“The decision this month was a non-event as nothing has changed in the comments from the central bank,” Rony Gitlin, head of spot trading at Bank Leumi Le-Israel Ltd. in Tel Aviv, said by phone. “The shekel reversed to small gains following higher moves in the euro-dollar rate.”

The Bank of Israel’s monetary committee sees the advance in oil prices and the exhaustion of the effect of domestic price reductions leading to a “relatively sharp increase in inflation expectations,” it said in an e-mailed statement accompanying the rate decision. Governor Karnit Flug has reduced borrowing costs 13 times since 2011, exhausting the central bank’s conventional toolkit as it seeks to shore up inflation, weaken a currency that’s battering exports, and boost economic growth.

“Salary increases should help boost inflation,” Flug said at a press conference in Jerusalem following the announcement.

While Israel is experiencing one of its longest periods of deflation, the central bank isn’t as worried, saying the trend is prompted by one-time government efforts to push down prices and by falling oil. Even with below-zero inflation, the country’s economic growth accelerated an annualized 3.9 percent in the three months ended Dec. 31, compared with 2.4 percent in the previous quarter. Borrowing costs are expected to remain unchanged until the first quarter of 2017, according to the Bank of Israel’s research department.

“The central bank would prefer to save its ammunition and keep borrowing costs where they are in coming months as recent economic data has been in line with expectations,” Sagie Poznerson, the head of trading at Leader & Co. Investment House in Tel Aviv, said by phone before the decision. “As we expect consumer prices to pick up in coming months, we view shorter-term inflation-linked government bonds as attractive.”

Traders have reduced their bets for the central bank to ease borrowing costs in the next few months with key indicators signaling that they will remain at a record low in the coming year. Shekel forward-rate agreements for the next six months, together with one-year interest rate swaps, are also trading at 0.1 percent.

The Bank of Israel has been battling a strong shekel, which appreciated 3.8 percent in the past 12 months, the third-best performer among 31 major peers. The strength of the currency is weighing on growth in exports which dropped 3.6 percent in February. They contribute about a third of Israel’s $306 billion economy.

Analysts, who had been been cutting their shekel forecast since the beginning of the year, have pared their expectations. The median estimate for the second quarter of 2016 is 3.90 per dollar, according to a Bloomberg survey of 21 forecasters. Analysts expect the shekel to weaken to 3.95 by the third quarter, and to trade at 3.98 by the end of the year.

Shekel-denominated 3 percent inflation-linked bonds due October 2019 declined for a second day, pushing the yield up 2 basis points to minus 0.36 percent. The yield on the benchmark 2025 government bond fell one basis point to 1.9 percent.

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