In Israel, as everyone knows, there is no fiscal policy at present. There is no budget, no government, and monetary policy has used up all its room for maneuver, unless the Bank of Israel decides on a program of quantitative easing to reduce interest rates. In these circumstances, only external factors can affect the basic conditions under which the Israeli economy operates.
Just such an external shock came late last week, when European Central Bank president Mario Draghi announced a €1.2 trillion quantitative easing program. Draghi came to the conclusion that fiscal policy in Europe was incapable of overcoming German fears, and that instead of encouraging growth it was encouraging deflation, unemployment, economic strangulation, and despair. In order to save the euro, the European Union, and the future of Southern Europe, he decided the time had come for a move of his own.
An immediate effect of Draghi's move was a substantial strengthening of the Israeli shekel against the euro, by almost 2.5%, and a 0.7% depreciation of the local currency against the US dollar. On the whole, it is possible to estimate, the effect on the Israeli economy, at the macro level, will be positive, although it will vary widely from one company to another, in accordance with the exposure each has to the dollar and the euro. Some companies will suffer, particularly if their exports are denominated in euros while their inputs are in dollars.
The euro could weaken further in the next few days as the results of the Greek election become clear. In an extreme case, the effects of currency exposure for some Israeli companies could be substantial, although some are already discounted in hedge transactions by Israeli exporters.
The main effect on the local economy will be felt only later on, when it becomes clear to what extent Draghi has succeeded in achieving the goals he set for himself. In an optimistic scenario, if it turns out that the markets are starting to believe that economic activity in the euro block will strengthen, and Germany manages to get over its fears, then the euro will strengthen, and will claw back some of its current weakness against the dollar.
The optimistic scenario is also based on the assumption that economic recovery in the euro block, even partial recovery, will lead to a rise in demand and an expansion of global trade. That will be reflected in Israel's export figures, which have been showing signs of recovery for several months. In conditions such as these, the Bank of Israel will be able to thank Draghi for saving it from the need to deal with a low growth rate with meager tools. The next Israeli government too will set out with a following wind.
On the other hand, there is also the pessimistic scenario, in which Draghi's move leads to a loss of confidence in him on the part of European governments, the weak economies fail to respond, and the financial markets come to the conclusion that the quantitative easing program will lead to a great crisis. Such a crisis of confidence will endanger the existence of the euro and put the global economy into a spin. Clearly, small, open economies like that of Israel will immediately suffer from a situation like this.
Mario Draghi presumably acted as he did out of a belief that he had no choice, and that he had to take this initiative, since the chances of success were greater than the chances of failure. In an uncertain world, the Bank of Israel can do nothing but cross its fingers for the European Central Bank president.
Published by Globes [online], Israel business news - www.globes-online.com - on January 26, 2015
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