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The Bank of Israel may have to show its cards on the currency this week or risk the market calling its bluff.
Despite repeated warnings that the central bank could intervene to weaken the exchange rate, the Israeli shekel has continued its run as one of the world’s best performers this year. That’s left inflation well below target and has investors doubting the resolve of Governor Amir Yaron to do anything about it.
The market is already pricing in a cut in interest rates as the central bank’s next move. While economists unanimously predict rates will stay on hold at 0.25% Wednesday, Goldman Sachs Group Inc. expects the committee’s official communication to “turn more dovish.”
“We continue to see structural appreciation pressures on the shekel, which could be reinforced if the Bank of Israel does not turn sufficiently dovish,” Bank of America Corp. economist Mai Doan said in a report. It “is not ready yet to guide for rate cuts, or to engage in any major FX purchases programs.”
Caught off guard by a turn toward monetary easing around the world, the Bank of Israel has little room for policy maneuvering since rates remain near zero after a single hike since 2011. Unless it’s willing to follow some developed economies and experiment with negative borrowing costs, the central bank’s options are limited as inflation sags further below its target range of 1% to 3%.
The question for Yaron, who took over in December with a goal of pushing up price growth toward the middle of the band, is whether he’s willing to go beyond what Bank of America has called a “neutral stance” he set out last month, when the governor said the key rate won’t rise for a “long time.”
“Last year the guidance was for gradual interest-rate increases and the picture right now is different, so I think we will have something about patience, something about steady interest rates for the long run,” said Alex Zabezhinsky, chief economist for Meitav Dash Investments Ltd., who believes there could be a small cut by the end of the year.
Here’s what else is in focus ahead of the decision:
Boosting the shekel are factors that range from Israel’s expected inclusion in a major bond index to increased natural gas production.
Policy makers have responded with threats to lean against the market, raising the possibility of deploying a program of interventions begun under former Governor Stanley Fischer.
This month, the central bank’s head of market operations said interventions are possible. Another Israeli publication then ran a story, without citing sources, that the bank was considering flooding the market with shekels in a non-sterilized intervention.
Despite occasional bouts of weakness that followed Yaron’s surprise comments on July 31, the Israeli currency is down about 0.3% against the dollar since then. JPMorgan Chase & Co. strategists took profits on their long bets on the shekel at the end of last month, citing its current levels and “recent dovish innovations” from the central bank.
Since the last rate decision on July 8, consumer prices have decelerated dramatically -- only rising an annual 0.8% in June and 0.5% in July.
The index has undershot forecasts for both months thanks in large part to a strong shekel.
The Bank of Israel’s average of inflation projections shows inflation at 1.2% over the next 12 months, barely creeping back into the target range and below the goal of reaching near the 2% midpoint.
Yaron hasn’t yet said what the central bank may do next, but expectations among some economists and investors have flipped already. Interest-rate swaps are now pricing in about 5 basis points of rate cuts over the next year.
While no change in rates is expected Wednesday, guidance could begin to shift. Goldman Sachs believes a “reference to interventions is possible.” The central bank’s governor has previously said the program is meant to help it combat “anomalous fluctuations” in the market.
“If they will do nothing, the shekel will start to increase again,” said Amir Kahanovich, chief economist for Phoenix-Excellence investment house.
--With assistance from Harumi Ichikura.
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