The Bank of Israel managed to surprise the market yesterday. Although it left its interest rate unchanged, the rate outlook that it provided for the rest of this year and for next year was more aggressive than expected.
Contrary to the hints dropped by other central banks around the world, the Bank of Israel expects one interest rate rise this year and two further rises in 2020. The capital market, on the other hand, is pricing in a very low probability of an interest rate rise before the end of this year.
The Bank of Israel stressed that inflation was approaching the mid-point of the government's 1-3% target range, and that for the first time since 2013 it had reached 1.5%. Nevertheless, the central bank also mentions the exchange rate as a factor likely to hold back the inflation rate from the mid-point of the target range.
"Surprisingly, the Bank of Israel's economists continue to expect one interest rise this year (in the third quarter), and two further rises in 2020. Although the governor of the bank again emphasized in his remarks that this was not a forecast by the Monetary Committee, it nevertheless remains a fairly surprising forecast," said Israel Discount Bank (TASE: DSCT) chief economist Nira Shamir.
"The governor qualified the forecast, however, saying that it was based on a large number of parameters about which there was an especially high degree of uncertainty at present. On the other hand, the governor mentioned global monetary policy as a factor, but not one that translates directly into policy in Israel. I would point out that the capital market expects the interest rate to be at 0.35% in a year's time," Shamir added.
"In general," she continued, "the question of global and local uncertainty was stressed several times in the governor's remarks. And as a result, according to him, it will be possible to continue to maintain an expansive monetary policy for a longer period in order to achieve the goals. We find it hard to see how the Bank of Israel Research Department's hawkish forecast lines up with the message that emerges from the governor's statements. What's more, we do not see an interest rate rise in 2019, particularly given world developments."
"Global developments will weigh on the local environment"
"The announcement was particularly surprising in the light of the emerging global environment," said Guy Beitor, head of macro research at Psagot Investment House. "On the one hand, the Bank of Israel placed an emphasis on the local inflation environment, which is on the rise, and pointed out that the tight labor market would continue to support rising wages that would eventually find expression in higher inflation. In addition, the Bank of Israel says that the economy continues to grow at close to its potential. On the other hand, the Bank of Israel recognizes the change in direction by central banks around the world, against the background of the slowdown in global economic activity and the decline in inflation in the developed world.
"Given the moderation in the global activity picture, we expected that this development would lead to a more moderate outlook for interest rate rises by the Research Department. The Research Department continues to estimate, however, that the interest rate will rise once this year and twice next year, to a level of 1.0%.
"In our view, at a time when the Fed and its European counterpart are starting a process of monetary expansion, it will be very hard for the Bank of Israel to raise interest rates in Israel, despite the emerging rise in the inflation environment.
"The Bank of Israel is in a problematic situation. On the one hand, the local environment supports a higher interest rate, but global developments can be expected to weigh on the local environment. The Bank of Israel states every time that the main risk factor to reaching the middle of the inflation target range is the appreciation of the shekel. In a scenario in which the Bank of Israel raises its interest rate while interest rates are being cut around the world, the probability of this risk materializing is very high. It therefore looks as though the Bank of Israel's hands are tied. The interest rate will remain unchanged for the foreseeable future, while the Monetary Committee's main tool in the short term will be intervention in the foreign exchange market as necessary," Beitor said.
Published by Globes, Israel business news - en.globes.co.il - on July 9, 2019
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