Strong Shekel, Slowing Growth, Gaza Led to Israel Rate Cut -

Bareksa.com - Slowing economic growth, very low inflation, a shekel that may have over-appreciated and the Gaza conflict led the Bank of Israel to lower short-term interest rates last month, minutes of the discussions showed on Monday.

The central bank unexpectedly cut its benchmark interest rate to 0.5 percent from 0.75 percent on July 28, matching the all-time low reached at the height of the global financial crisis in 2009. All six monetary policy committee members voted for the rate cut.

"All the committee members agreed that reducing the interest rate ... is a necessary step in light of the decline in the inflation environment, the slowdown in GDP growth, and with it the uncertainty regarding the moderating effect of Operation Protective Edge (in Gaza) on growth, the cumulative appreciation of the shekel, and the concern over continued slowdown in the global economy," the central bank said.

After the cut, Bank of Israel Deputy Governor Nadine Baudot-Trajtenberg told Reuters there was no need for further reductions.

Israel's economy is forecast to grow 2.9 percent in 2014 after a 3.3 percent spurt last year, although the central bank believes the Gaza conflict could shave off as much as a half-point from growth. The impact from lost tourism could be seen for several quarters, while the effect on trade and services will likely be short-term, it said.

"As can be learned from similar events in the past, the effect on the economy's rate of growth will apparently be moderate," the central bank said.

The strong shekel was another key reason for the rate cut, which came in contrast to the predictions of all 10 economists polled by Reuters. Since the reduction and following market intervention, the shekel - which had hit a 3-year high versus the dollar last month - has weakened 2 percent to a rate of 3.47. It had risen some 10 percent since early 2013.

"Committee members referred to the shekel's prolonged appreciation, and they assessed that the level of the exchange rate reflects some over-appreciation," the minutes said. They "expressed concern over further appreciation, especially in light of the slow growth in world trade volumes."

LOW INFLATION

Forces strengthening the shekel include a current account surplus, large volume of direct investment in the economy, and institutional investors' hedging of investments abroad.

Low inflation, in which the annual rate fell to a seven-year low of 0.5 percent in June, enabled the central bank to cut rates. Policymakers expect inflation to remain below a target range of 1-3 percent for months ahead and agreed that the decline has stemmed from lower food and energy prices.

But the MPC was split as to the reason, with some believing the moderation was due to weakness in domestic demand, while others said low inflation was temporary and is not expected to have an impact on activity.

"Committee members agreed that action should be taken in order to return the inflation rate to within the price stability range within the coming 12 months," the minutes said.

The MPC also noted that the decline in corporate bond spreads stopped after a moderation in the amount of new investment in corporate bond mutual funds and for the first time in two years there were net withdrawals.

"Spreads are still at a low level, and the risks to financial stability from that market should be monitored," the central bank said. (Source : Reuters)