Israel extended its longest cycle of monetary tightening in decades, surpassing an interest-rate hike by the US Federal Reserve for the first time since starting to raise borrowing costs in April.
(Bloomberg) —
Israel extended its longest cycle of monetary tightening in decades, surpassing an interest-rate hike by the US Federal Reserve for the first time since starting to raise borrowing costs in April.
The central bank lifted its benchmark rate on Monday to 4.25% from 3.75%. Most economists surveyed by Bloomberg expected an increase of a quarter percentage point, matching the Fed’s last move.
Speaking in an interview after the decision, Deputy Governor Andrew Abir said future calls will be “very data dependent” and wouldn’t specify how close the central bank might be to ending its cycle after eight straight increases.
The shekel traded 0.8% weaker against the dollar as of 7:27 p.m. in Tel Aviv, on track to close at the weakest since early November.
With borrowing costs already at the highest since 2008, the Bank of Israel is now having to contend with a bout of political turbulence that helped make the shekel the worst-performing currency in the Middle East this month, after the Lebanese pound.
Prime Minister Benjamin Netanyahu and allies are looking to make it easier for the state to appoint judges and limit the Supreme Court’s authority to strike down legislation. It’s a proposal that’s triggered weeks of protests among Israelis and prompted a high-profile resignation of a member of the central bank’s monetary committee.
Abir said “political uncertainty” in Israel has affected the exchange rate and equity markets but the central bank has yet to see any direct impact on capital flows. Strong institutions are an important factor for the long-term economic outlook, he said, though the turbulence may not change Israel’s immediate prospects.
In an indication of the high political stakes involved in monetary policy, Israel’s Foreign Minister Eli Cohen condemned the latest rate hike soon after the decision and urged the government to intervene to end the cycle. Bank of Israel Governor Amir Yaron responded that it’s important to understand the importance of an independent central bank.
Rate Path
The Bank of Israel started to raise borrowing costs in smaller increments from November even as inflation shows little sign of easing. Yaron has signaled policymakers “are determined” to bring price growth back into its target range and expects a deceleration to take hold after February.
Price gains, above the official target range of 1%-3% for over a year, unexpectedly accelerated to an annual 5.4% last month. Higher energy costs for households, alongside housing inflation, were among the biggest drivers of price increases in January.
The most recent inflation reading suggested price growth is “pretty sticky, particularly in the services sector,” Abir said. Inflation may slow below 5% toward mid-year, in part because of favorable statistical base effects.
Expectations in the market are for more monetary tightening ahead. Israel’s one-year currency swaps indicate investors see the base rate rising to around 4.5% a year from now.
Though expected to moderate in the months ahead, inflation is also coming under pressure from the shekel, whose strength was once a key factor in holding back consumer prices. It’s down around 3% against the dollar so far in February.
Closely correlated with the performance of US equities, the Israeli currency lost nearly 12% last year in its worst performance since 1998. The political backlash against the government’s plans to reshape the judiciary has also become a factor, stoking a depreciation that makes imports more expensive.
In its statement on Monday, the central bank highlighted that “exchange rates have been characterized by considerable volatility” but didn’t specify how that may have affected its decision.
Jonathan Katz, macro strategist for Leader Capital Markets, said the shekel’s volatility was likely “the swing factor” for the Bank of Israel.
“It’s pretty clear that unless there’s a reasonable compromise on the judicial reform issue in the near term, one that the government and opposition can agree on, we’ll see continuing pressure on the shekel,” Katz said.
–With assistance from Harumi Ichikura.
(Updates with central banker comment starting in third paragraph.)
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