Israeli Interest Rate Cut Bets Fizzle Out as Central Bank Protects Shekel

Israel’s central bank underscored the urgency of steadying the shekel following its slide to an eight-year low, shifting expectations among economists and traders who bet on a big interest-rate cut as soon as next week.

(Bloomberg) — Israel’s central bank underscored the urgency of steadying the shekel following its slide to an eight-year low, shifting expectations among economists and traders who bet on a big interest-rate cut as soon as next week. 

Citigroup Inc. reversed its forecast for a 75-basis point reduction on Monday, saying the central bank will likely keep the benchmark unchanged and may only ease policy once the shekel weakness subsides. HSBC Holdings Plc said it sees “little scope for the Bank of Israel to turn markedly dovish at this stage.”

Israel’s wartime monetary policy is taking clearer shape 11 days into a crisis that started with the deadly Hamas assault on the country. Concerns over the impact of a prolonged war on the $520 billion economy initially fueled wagers on easing. 

But on Tuesday, Deputy Governor Andrew Abir said the central bank is focused on stabilizing markets to give the “maximum certainty for the economy and the public at this time,” signaling it will avoid monetary steps that could imperil the shekel’s stability.

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Following a pledge to sell as much as $30 billion from reserves to support the currency, policymakers have succeeded in taking the edge off the foreign exchange market, which “has contributed to stabilizing and calming other markets as well,” Abir said Tuesday at a meeting with financial forecasters.

The verbal intervention is prompting traders to unwind bets on easing ahead of the central bank’s rate decision on Monday, its first since the militant group’s Oct. 7 attack on Israel triggered retaliatory bombardments of Gaza ahead of a likely ground invasion.

Forward-rate agreements, used to wager on future changes in borrowing costs, jumped by the most in more than a year on Tuesday, after falling by more than one percentage point last week. 

The shekel fell 0.2% to 4.0193 against the dollar on Tuesday, after paring losses of as much as 0.5%. Fitch Ratings report said it may cut Israel’s A+ debt ratings on the heightened risk of a wider conflict.

Underlining the threat facing the region, the leaders of Jordan, Egypt and the Palestinian Authority canceled a summit with US President Joe Biden that had been scheduled for Wednesday in Amman after an explosion at a Gaza hospital left hundreds dead.

“The Bank of Israel initiated its latest announcement to cool expectations of an interest-rate reduction created in markets,” said Alex Zabezhinsky, chief economist at Meitav DS Investments. “The central bank clarifies that for the time being it prioritizes financial stability and certainty rather than a change in the monetary regime.”

A hold next week would extend a pause in place since July, which followed a record-long cycle of monetary tightening. The central bank raised its key rate sharply 10 consecutive times starting in early 2022 — from barely above zero — to 4.75%, bringing official borrowing costs to their highest since 2006. 

“Stable rates are more likely than renewed policy tightening,” Melis Metiner, an economist at HSBC, said in a report. “Policymakers are likely to want to see evidence of rapid exchange rate pass-through to prices or deteriorating expectations before considering raising the key rate.”

While offering relief to borrowers and businesses at a moment of national peril, rate cuts now would contradict the Bank of Israel’s unprecedented efforts to smooth out fluctuations in the exchange rate after a depreciation that officials consider the biggest risk for inflation.

Rather than opting for looser monetary policy, Israel is more likely to lean on “fiscal adjustments” to provide support for the economy, said Yonie Fanning, chief strategist for Mizrahi-Tefahot. 

“While a November cut may still be on the table, we believe that a cut next week coincides less with current macroeconomic and financial conditions,” Fanning said.

Economists at Barclays Plc said last week’s rally in the local fixed-income market implied market expectations of about 75 basis points of cuts over the next three months.

“This is excessive as we do not expect the Bank of Israel to change its policy rate this year,” Barclays analysts including Brahim Razgallah and Zalina Alborova said in a note.

–With assistance from Kerim Karakaya.

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