August 29, 2018 / 1:42 PM / 8 months ago

UPDATE 2-Bank of Israel holds key rate, warns stronger shekel may hold back inflation

* Key rate has stayed at 0.1 pct since February 2015

* Shekel gained 2.3 pct vs currency basket since last decision

* Central bank downplays weak Q2 growth, sees faster growth in Q3

* Bank of Israel Governor Karnit Flug set to step down in November (Adds shekel reaction, analyst comment)

By Steven Scheer

JERUSALEM, Aug 29 (Reuters) - The Bank of Israel on Wednesday held its benchmark interest rate at 0.1 percent for the 36th straight time since early 2015, cautioning that a stronger shekel could keep inflation from settling into its 1 to 3 percent target.

The shekel has appreciated by 2.3 percent against a basket of currencies of key trading partners since the last rate decision on July 9, mainly because of weakening of emerging markets currencies, the central bank said in a statement.

“The rise in the inflation environment continues ... and it appears that the inflation environment is moving toward entrenchment within” the target, it said, noting that inflation expectations for the next year are near 1 percent.

“The main risk to the entrenchment of inflation within the target is the possibility of a sharp appreciation in the shekel.”

Israel’s annual inflation rate gained to 1.4 percent in July from 1.3 percent in June, when it topped 1 percent for the first time since 2014.

Bank of Israel Governor Karnit Flug has said that for rates to rise, inflation needed to be entrenched within the government’s annual target range of 1 to 3 percent.

The shekel strengthened to 3.625 per dollar from 3.64 just before the announcement.

“The monetary committee’s sensitivity to the shekel is a sign that without a prolonged depreciation of the shekel, it is difficult to expect a rate hike,” said Jonathan Katz, chief economist at Leader Capital Markets.

All 10 economists polled by Reuters had forecast no rate change by the central bank, which is expected to leave rates on hold until at least later in 2018 before tightening policy.

Analysts are split over the timing of a rate increase. Some, including the central bank’s own economists, expect a 15-basis-point increase in the fourth quarter. Others believe an increase won’t come until 2019. Katz estimates the second quarter next year.

Over the past decade, the central bank has responded to a stronger shekel with intervention. It has bought more than $85 billion of foreign currency since 2008, but just $2.6 billion so far in 2018.

The central bank downplayed a slowdown in second-quarter economic growth to a 2.0 percent rate from 4.8 percent in the prior three months, saying most of the decline in growth derived from fluctuations in vehicle imports.

“Current indicators of activity support the assumption that the economy has returned to a faster pace of growth in the third quarter,” the Bank of Israel said, reiterating the labour market remains tight and wages continue to rise at a solid pace.

The central bank forecasts 3.7 percent growth this year.

It noted that a downward trend in housing prices that began a year ago has halted.

Wednesday’s decision may be the second-to-last for Flug, who said last month she would not stand for a second five-year term when her tenure ends in November. If a new governor is not in place by November, Flug’s deputy, Nadine Baudot-Trajtenberg, is likely to replace her in the interim.

The next decision is slated for October 8, at which time the central bank will provide updated economic forecasts.

For full report:

here (Reporting by Steven Scheer, editing by Larry King)

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