As Israel approaches another rate decision next week, macroeconomic developments are posing challenges to monetary policy. Alarmingly, growth decelerated to just 0.3% q/q (saar) in Q2 from 2.0% in Q1 and 2.7% in 2014. A steep decline in export volumes during Q1 and Q2 implies that the ILS is too strong.



"Other factors are a slowdown in global trade and a drop off in consumption growth. Although Israeli growth data are often subject to revisions and other monthly indicators still imply steady growth, 2015 and 2016 growth is forecasted to 2.3% from 3.1% and 3.3%, respectively", says Barclays.



The growth slowdown puts more pressure on the Bank of Israel (BoI) to loosen monetary policy. In addition, inflation remains below zero (-0.3% y/y in July) and inflation expectations have fallen. The BoI has only minimal room to manoeuvre with its policy rates already quite low at 0.1% and reluctance to introduce negative rates.



The BoI has been intervening, purchasing USD5bn this year unsterilized, with the goal of weakening the ILS, causing money supply to expanded. The ILS had appreciated further until this week, but has weakened on interventions from both the BoI and Ministry of Finance.



"The ILS weakness gives the BoI room to stay on hold next week. Furthermore, the BoI would probably prefer to hold off and see what the US Fed does in September. Clearly there is pressure is on the BoI to find some method to loosen monetary conditions", added Barclays.