Israel's central bank cut its benchmark interest rate by 25 basis points to 0.75 percent after a surprise fall in January inflation, pessimism among consumers and continued strength of the shekel.
The Bank of Israel (BOI), which cut its rate by 75 basis points in 2013, said the decision to cut the rate was consistent with the bank's aim of entrenching inflation within a 1-3 percent range and it would use its tools to achieve this objective along with encouraging growth and employment while it would continue to keep a close watch on asset markets, including the housing market.
Israeli consumer prices fell by 0.6 percent in January, higher than an expected 0.2 percent fall, pushing down the annual inflation rate to 1.4 percent from 1.8 percent in December. As a consequence, private forecasters reduced their inflation projections to an average of 1.6 percent over the next 12 months while capital market's expectations were steady at 1.9 percent and inflation expectations derived from banks' own interest rates were unchanged at 1.4 percent.
Private forecasters and market interest rates also indicated "some probability" of a cut in rates by the BOI over the next three months while expectations for a cut over the next year are lower and some forecasters even expect an interest rate increase, the central bank said.
Since the beginning of the year, Israel's shekel has depreciated by almost 1 percent and immediately fell further after the rate cut, dropping to 3.517 to the U.S. dollar from 3.50 before the announcement.
But since the start of 2013, the shekel has risen by 7.3 percent the bank said, despite the BOI's efforts to hold down the shekel's exchange rate by intervening in the foreign exchange market to help the country's exporters that account for some 40 percent of the economy.
This year the BOI has targeted foreign exchange purchases of $3.5 billion, up from $2.1 billion in 2013, to help offset the impact of natural gas production on the exchange rate.
Recent data show that Israel's economy is "growing at a moderate pace," with estimates showing that fourth quarter Gross Domestic Product expanded by an annual rate of 2.3 percent, down from 3.3 percent in the third quarter, with a turnaround in exports mainly to volatile pharmaceutical exports while exports from labour-intensive industries are at a virtual standstill, the BOI said.
Various indicators of activity in January point to some recovery but consumer confidence indices continue to signal pessimism and there is a lack of growth in employment and wages in business.
Israel's unemployment rate rose to 5.8 percent in December from 5.5 percent the previous month with real wages declining by 0.4 percent in the September-November period from June-August.
Isreali home prices, which are not included in consumer prices, rose by an annual 8.1 percent in December, up from 7.9 percent in November, and the number of transactions hit its highest level since 1997 with the share of investors in transactions steady at around 22 percent, the central bank said.