It has not been an easy month for the traders, operatives, and analysts in the government bond market, and to some extent also in the foreign currency market. The decision yesterday by the Bank of Israel Monetary Council, headed by Governor Karnit Flug, to leave the interest rate unchanged is making all of them consider their next moves.
The decision making process by those active in the market is now affected to a considerable degree by the Bank's announcement, which listed the reasons why an interest rate cut was postponed. It is important to understand the dynamic and the reasons that brought about the decision not to employ extraordinary tools for the moment, despite the macroeconomic and inflation figures. This will become clear in a few days, when the protocols of the Monetary Committee's discussions are published. Then we will know the main reasons for the additional wait, and whether there were members of the Committee who supported lowering the interest rate and adoption of quantitative easing now. It will be no less important to see what Flug's position was.
An educated guess is that the Committee eventually decided in favor of waiting because it thought that it lacked sufficient data to decide otherwise. A month from now, not only will it have the numbers for the third quarter; it will also have partial data for the emerging trends in the fourth quarter. This is important, because it will involve the Committee making decisions in a state of instability and risk.
A decision on the basis of the third quarter only, with the effect of the war in the south during the summer months, would have led to a decision to lower the interest rate. The same is true of the slowdown, deflation, and low global growth - a body of data on which the Bank of Israel commented in its announcement yesterday, and which usually leads to an interest rate cut in order to get the economy going.
It can be assumed, however, that the Committee members believed that the economy's rate of recovery should be examined, and whether it is shifting into higher gear. A month from now it will be difficult to determine whether the economy is recovering or slowing, but the decision will have to be taken, unless the Governor and Committee members prefer to wait a few more weeks to consider the situation. These two alternatives (lowering the interest rate, combined with quantitative easing, or waiting another month) both incur risk. One risks an unnecessary injection of liquidity, and the other runs the risk of a worsening of the economic slowdown.
Another parameter that will determine the Bank of Israel's decision a month from now is the developments in the foreign currency market. The Bank of Israel very much wants to see signs that the capital market and the exporters regard the devaluation in recent weeks as a long-term trend, or at least as a devaluation that will not be wiped out in a few weeks. The Committee assumed that even if there is an immediate shekel appreciation as a result of the decision not to lower the interest rate, it will be only temporary.
Developments in the global foreign currency market and the behavior of the investment institutions in Israel, who have reduced the hedge by investing in foreign assets, should support a prolonged depreciation that may make the question of quantitative easing less urgent.
Published by Globes [online], Israel business news - www.globes-online.com - on October 28, 2014
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