Fed Tightening To Keep Shekel Competitive

 

With most Central Bankers of advanced economies facing a similar conundrum of deflation, the willingness to raise rates is notably absent with many policymakers fearing the deflationary trap currently faced by the Bank of Japan. However, with the United States making the first liftoff move, other developed nations are likely to reap the benefits especially if the US dollar rally should persist. Israel in particular should gain from these developments after rates were dropped to record lows in order to fight off deflation and stimulate the economy. However, aggressive easing measures have not led to a notable decline in the shekel, a phenomenon policymakers are hoping will be fixed by the Federal Reserve’s more hawkish bias.

The Fundamental Perspective

On the whole, Israel has not been immune from global developments, especially as an export oriented economy. However, the strong focus on technological and agricultural exports has enabled the country to remain stable at a time when international trade is largely faltering. Both manufacturing and industrial production remain in expansionary territory and the process of developing and extracting gas from some of the largest Mediterranean fields ever discovered should provide a great boost for the Middle East’s strongest economy. On a per capita basis, Israel ranks among the most productive nations in the region, only overshadowed by several oil-rich gulf nations which are more highly dependent on the prices of key energy products to keep the state coffers filled. By comparison, Israel boasts a much more diversified economy.

The loosening cycle for monetary policy that began back in 2011 has gone largely unabated, with the Bank of Israel leaving the benchmark unchanged for 9-straight meetings at a record low 0.10% after dropping the rate to current levels back in February. The Bank of Israel is unlikely to move on rates anytime soon in light of the inflation situation with the consumer price index. According to the latest reading, consumer prices have declined by -0.90% year over year, indicating an economy that is firmly in deflationary territory. This will definitely impact policy going forward, as the Bank of Israel will be forced to keep conditions accommodative in order to stoke inflation and escape from current deflationary conditions. Core inflation has managed to stay in positive territory, but this is likely due to the removal of more volatile components such as energy.