Bank of Israel unexpectedly reduces benchmark rate following appreciation of shekel

Growth could begin to pick up speed after Israel’s central bank unexpectedly reduced its benchmark rate to a record 0.1% from 0.25% in an attempt to offset deflationary pressures.

The main factor contributing to the lowered rate was the appreciating shekel, though the trend of negative inflation played a role as well.

“The Monetary Committee is of the opinion that in view of the increased rate of appreciation, and its possible effects on activity and inflation, reducing the interest rate to 0.1% is the most appropriate step at this time in order to support achieving the policy targets,” the committee wrote in its decision.

Although the shekel is far weaker than it was last summer, having depreciated 10.4% between August and December against a basket of currencies, it has appreciated 7.6% since December.

Bank of Israel is enacting looser monetary policies as it tries to stimulate a flagging economy that has expanded at its slowest pace in five years and reverse the decline in consumer prices.

The Israeli economy grew 2.9% in 2014, its weakest pace since 2009, and experienced several months of deflation, with consumer prices dipping 0.5% in the 12 months through January. In contrast, the country is aiming toward an inflation rate of 1% to 3% within a year.

Specialists say the central bank may even contemplate a potential bond-purchasing program, or so-called unconventional tools, of its own if deflationary pressures persist.

The rate cut “is a preventative measure meant to avoid a slide into a deflationary reality,” Yaniv Pagot, chief strategist at Ayalon Group Ltd. in Ramat Gan, said.

In the article. “Quantitative easing steps in the not so distant future cannot be discounted.”

In an interview with The Jerusalem Post earlier this month, BOI Governor Karnit Flug noted that, “If you subtract the effect of the price reduction of electricity and water, we would actually be standing at 1.5% inflation according to that projection of the research department, based on an interest rate at the current level.” The latest projections put long-term inflation expectations.

The change comes despite a healthy jobs markets and an economic bounce-back in the last quarter of 2014. The summer war with Hamas in Gaza nearly halted growth in the third quarter, but the economy rebounded with 7.2% annualized growth the following quarter.

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