Currency Joins Virus on Israel’s Problem List With Rate Held
Bank of Israel to Pass Baton of Crisis Fight With Rate Near Zero
(Bloomberg) -- The Bank of Israel’s policy agenda has come full circle with a warning that an appreciating shekel might risk the recovery of exports and inflation just as the economy opens up after a near-total shutdown.
After a historic contraction to start the year, policy makers improved their economic outlook and held their key interest rate steady at 0.1% on Monday, a move unanimously expected by analysts.
But in a statement, the monetary committee noted that the currency’s appreciation since the last rate decision in early April risked tamping down trade and consumer prices. The shekel erased gains after the announcement and traded little changed at 3.5302 against the dollar as of 6:16 p.m. in Tel Aviv.
“To the extent that the exchange rate stabilizes at this level, it will weigh on the recovery of exports, particularly in view of the decline in global demand, and on the return of inflation to within the target range,” the central bank said.
Before the crisis flared, a program of foreign-currency purchases was the central bank’s preferred tool for delivering looser policy. It paused buying in March while focusing on emergency measures to stabilize markets and has since resumed interventions, designed to weaken the shekel and prop up inflation.
After a bout of weakening, the shekel has been on a roll, and is the second-best performer globally against the dollar since mid-March with a gain of over 8%.
Exports and inflation could both be negatively impacted by the shekel’s strengthening, according to officials. Barclays Plc analysts said in a recent note to clients that the pace of currency interventions could return to previous levels of around $3 billion per month.
Changing Role
After playing a leading role during the early response to the coronavirus pandemic, the Bank of Israel is now moving onto the sidelines while urging the government to boost activity with expansionary measures. Even as the economy began 2020 with its worst quarter in at least 25 years, the contraction was far more shallow than anticipated, while high-frequency indicators like credit card spending are already showing signs of a rebound.
The economy shrank a seasonally adjusted, annualized 7.1% in the first quarter. Exports were a relative bright spot, declining just under 6%. Israel is exiting the restrictions the government imposed to contain the coronavirus. There have been roughly 280 deaths and 17,000 cases.
The country is also at risk of deflation, with the International Monetary Fund projecting Israel will face the steepest price declines in the world this year. Annual inflation has settled under the low end of the central bank’s 1% to 3% target range over the past year, reaching minus 0.6% last month.
Policy makers also repeated their previous guidance that the central bank could expand the use of existing tools, including rates, and introduce new ones depending on the length of the crisis.
Central bank researchers revised their outlook for this year and next, predicting a more shallow contraction of 4.5% in 2020 and a smaller rebound of 6.8% in 2021. They previously forecast the economy would contract 5.3% this year before expanding 8.7% in 2021. A Bloomberg survey of economists forecast a 3.3% reduction in 2020 output.
At the height of the outbreak starting in March, the central bank rolled out unprecedented measures including 50 billion shekels ($14.2 billion) worth of government bond purchases. Weeks later, it cut borrowing costs, unveiled new tools, and even broached the possibility of cutting rates yet further.
Bank of Israel Governor Amir Yaron is now calling for the government to expand fiscal policy as the country lifts its lockdown. Yaron told the government’s cabinet on Sunday that officials should avoid contractionary measures that may harm the return to growth.
“The crisis created a new reality in which it is correct to temporarily increase the deficit and debt in order to prevent prolonged damage to the economy,” Yaron said. “Expanding budgetary expenditure at the current stage will help accelerate the exit from the crisis.”
New Government
Israel ended more than a year of political paralysis by swearing in a new emergency government last week, tasked with handling the coronavirus crisis. New Finance Minister Israel Katz has already increased crisis spending to bring total fiscal aid to roughly 100 billion shekels.
“This is the midst of the crisis, and I think we need to take every possible step to actually try to get as many people back to work as we can,” said Karnit Flug, a former Bank of Israel head now at the Israel Democracy Institute research center. “And on fiscal policy that means expansionary policy.”
Still, depending on the length of the crisis, monetary policy makers have left themselves room for further easing. After its last meeting in April, the central bank signaled it could be rethinking its long-held reluctance to push borrowing costs below zero.
Markets and analysts also see some scope for a reduction down the road. One-year interest rate swaps are pricing in a slight decrease over the coming year.
Israel’s real rates are quite high internationally, so there’s a case to be made for cutting them further into negative territory, according to Guy Beit-Or, head of macro research at Psagot Investment House.
The currency’s performance may also shape policy in the months ahead. The shekel’s appreciation was the result of fundamental factors such as Israel’s current-account surplus, and potentially the economy’s relatively quick recovery from crisis, said Bank Leumi Le-Israel chief economist Gil Bufman.
“The strong shekel is going to be a thing to keep an eye on for the long term,” he said.
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