The Bank of Israel (BOI), which cut its rate by 75 basis points in 2014, said the rate cut was "the most appropriate step at this time in order to support achieving the policy targets."
BOI, which targets inflation of 1-3 percent, noted that consumer prices had dropped by a larger-than-expected 0.9 percent in January, with the annual inflation rate falling to minus 0.5 percent, the fifth month in a row of deflation and down from minus 0.2 percent in December.
A one-off reduction in water prices, a drop in housing prices and lower energy prices were mainly responsible for the drop in inflation but a cut in electricity prices is expected to pull down February inflation by 0.3 percent.
After news of the rapid pace of deflation in January, the BOI said short-term inflation expectations remained below its target range while longer-term forecast fell 0.2 points to just above 2.0 percent.
Israel's shekel currency bounced back and appreciated by 2.6 percent against the U.S. dollar from late January to the present following a depreciation from August to early December, which resulted in only a 2 percent cumulative depreciation since August.
" Continued appreciation is liable to weigh on growth in the tradable industries-exports and import substitutes," the BOI said.
The shekel eased slightly following the BOI's decision, dropping to 3.9 to the dollar from 3.86.
The Bank of Israel issued the following statement with its main reasons for the rate cut:
"The main considerations behind the decision
The decision to reduce the interest rate for March 2015 by 0.15 percentage points, to 0.10 percent is consistent with the Bank of Israel's monetary policy, which is intended to return the inflation rate to within the price stability target of 1–3 percent a year over the next twelve months, and to support growth while maintaining financial stability. The path of the interest rate in the future depends on developments in the inflation environment, growth in Israel and in the global economy, the monetary policies of major central banks, and developments in the exchange rate of the shekel.
Concurrently the Bank has decided to narrow the interest rate corridor in the credit window and the commercial bank deposit window from ±0.25 percent to ±0.1 percent.
The following are the main considerations underlying the decision:
- The CPI declined by 0.9 percent in January, against the background of a decline in energy prices, a scheduled reduction in water prices, and a relatively sharp decline in the housing component. The rate of inflation as measured over the past 12 months was negative 0.5 percent, as the decline in energy prices had a direct effect of reducing the CPI by 0.7 percent. The one-off reduction in electricity prices is expected to contribute -0.3 percent to the CPI for February. After the January CPI was published, short term inflation expectations from all sources remained below the target range, and there was a slight decline in longer term expectations toward the midpoint of the target range.
- In the fourth quarter the increase in the employment and labor force participation rates continued, as did the decline in the unemployment rate and the increase in the number of job vacancies. The high rate of growth in the fourth quarter came against the background of the recovery from the effects of Operation Protective Edge, and primarily reflected growth in public consumption, and growth in exports that continued in January as well in view of the cumulative depreciation since August. Tax revenues continued to increase in January, at a rate similar to that of recent months.
- This month, the shekel continued its appreciation, strengthening by 2.6 percent against the dollar, and by 3.3 percent in terms of the nominal effective exchange rate. After a depreciation of 10.4 percent between August and December in the effective exchange rate, there has been an appreciation of 7.6 percent since December, so that the cumulative depreciation since August has only been 2 percent. Continued appreciation is liable to weigh on growth in the tradable industries—exports and import substitutes.
- Inflation rates in major markets continue to decline to very low levels, and this month various central banks implemented additional monetary easing measures. In the US, growth was slightly more moderate than expected, and there is uncertainty regarding the date that the federal funds rate will begin to be raised there.
- In the fourth quarter, there was an increase of 22 percent in housing market transactions, consisting of purchases by young couples and by buyers upgrading their homes, while the number of transactions involving investors remains stable. The moderate decline in the number of new homes for sale continues, and the rate of mortgages being taken out remains high. Corporate bond market spreads increased slightly this month, but they remain low.
The Monetary Committee is of the opinion that in view of the increased rate of appreciation, and its possible effects on activity and inflation, reducing the interest rate to 0.1 percent is the most appropriate step at this time in order to support achieving the policy targets.
The Bank of Israel will continue to monitor developments in the Israeli and global economies and in financial markets. The Bank will use the tools available to it and will examine the need to use various tools to achieve its objectives of price stability, the encouragement of employment and growth, and support for the stability of the financial system, and in this regard will continue to keep a close watch on developments in the asset markets, including the housing market."