Bank of Israel Seeks to Distance Itself From Fed Rate TrajectoryBy
Subtle change in forward guidance confuses some in market
Bond yields drop and shekel strength ebbs on dovish message
The Bank of Israel has a new message for the market: Don’t assume it will follow the U.S. path on interest rates.
Investors and economists long speculated that the Bank of Israel, anxious about a strengthening local currency, would keep rates on hold until the U.S. Federal Reserve had raised its lending rate a few times. As the rate differential grew, ensuring the shekel wouldn’t appreciate too quickly, the BOI would eventually begin a tightening cycle of its own -- or so the logic went. But after the central bank changed its forward guidance in its April monetary policy decision, that may no longer be a foregone conclusion.
The central bank, which has kept rates at an all-time low for more than two years, now says policy will stay loose until the inflationary environment is entrenched “within the target range” of 1 percent to 3 percent. That’s a change from its previous guidance, which was that rates would stay low for a “considerable time.” Tying monetary policy to the inflation environment rather than to a time-frame helped investors understand that central bank policy isn’t necessarily going to mimic the U.S., according to a Bank of Israel official.
The official said the market so far has absorbed the message as dovish: Bond yields have fallen and the Tel Aviv Interbank Offered Rate, a benchmark for local lending, has dropped since the change was announced. While there are plenty of global factors also influencing the market, those signals suggest investors no longer expect the Bank of Israel to raise rates within the next 12 months.
Still, market reaction has been muted, perhaps because the BOI’s guidance could be interpreted in various ways, says Rafael Gozlan, chief economist at Israel Brokerage & Investments Ltd. in Tel Aviv. In a meeting with economists after the guidance change, Bank of Israel officials were peppered with questions from analysts unsure how to interpret the new messaging. Gozlan previously had urged the bank to announce it would keep rates on hold until inflation reached the mid-point of its target range.
“A recent uptick in inflation may have been a bit misleading,” Gozlan said, adding that it was clear to him the bank’s change was “very dovish” and thus there’s room for yields to fall further.
“In theory, it’s true that if we had high inflation it would be a hawkish statement. But given that inflation will continue to be low, we may have a central bank on hold for longer than expected,” he said.
Other economists, including Alex Zabezhinsky, chief economist at Meitav DS Investments Ltd. in Tel Aviv, aren’t so sure. Considering that inflation rose 0.7 percent in April and inflation expectations have increased, the new guidance could be seen as reflecting a hawkish turn, he said. The central bank also is closely watching a sharp rise in household leverage, which could stoke a debt crisis if not addressed in time, he said.
“The economy is doing well, inflation changed direction and is moving toward their goal,” Zabezhinsky said. But he acknowledged it’s hard to be sure how to interpret the central bank’s message, and that much will depend on upcoming growth and inflation data.
Even within the BOI’s monetary policy committee, one of the four members argued against the change in forward guidance in April. His argument: Because prices have been falling due to positive circumstances, such as more competition in the economy, it would be incorrect to link monetary policy to the inflation path.
It’s possible the central bank will refine its messaging to clear up any confusion. But for now, BOI officials say the message has been absorbed as yields drop and the shekel largely has stopped appreciating.
The Bank of Israel kept rates on hold again at last week’s monetary policy meeting and took the opportunity to highlight that the inflationary environment is still weak. While the bank noted that strong economic activity is boosting prices of non-tradable items and lifting inflation expectations, the strong shekel is making imports cheaper, contributing to a decline in prices of tradable goods.
The bank also said that “increasing competition in the economy, as well as additional policy measures announced by the government,” such as reducing purchase tax and customs on various products, “may continue to slow the return of inflation to the target range.”