The Bank of Israel's decision to cut the interest rate to a low of 0.1% surprised the economy, and immediately aroused a great deal of commentary centering around the question of its effect on the housing market. For some reason, one question has been left out of the public discourse - how the Bank of Israel will act to achieve its target, after having exhausted interest rate cuts as a tool of monetary policy.
One possible answer to the question is included in the Bank of Israel's announcement accompanying the interest rate decision: "The Bank of Israel will use the tools at its disposal, and will consider the need to use various tools in order to obtain its objectives." This sentence comes on top of the announcement by the Bank of Israel of the interest rate decision several months ago, which made it clear to everyone that it referred to a possible return to quantitative easing, meaning the purchase of government bonds as a means of ensuring monetary expansion.
In order to understand the Bank of Israel's objectives, the achievement of which will justify the use of quantitative easing, we have to return to the array of explanations given for the lowering of the interest rate this month. According to the Bank of Israel's announcement, it wants to maintain the growth momentum from the fourth quarter of 2014 and a return to a GDP growth trend of more than an annual 2.5%.
In the Bank's opinion, the shekel devaluation in the third quarter of the year helped boost growth. Since December, however, the devaluation has been reversed, and the Bank is therefore acting to maintain the strength of exports. In addition to the economic growth aspect, the Bank of Israel is also taking action to bring inflation back within the official 1-3% annual target. The 0.9% drop in the Consumer Price Index in January and a further drop in February are just one more stage in a series of declines that have put annual inflation into negative territory, and inflation expectations below an annual 1%.
The Bank of Israel cannot remain indifferent to such figures, because they are within the sphere of its mandate. Had the exchange rate figures reflected continued devaluation, the Bank might have waited for a while before lowering the interest rate. Indeed, it was the third quarter devaluation that persuaded the Bank of Israel not to lower the interest rate below an annual 0.2% at the beginning of the fourth quarter of 2014.
This situation has changed, and the circumstances in which the Bank of Israel decided to reconsider an interest rate cut occurred already in January. It should be pointed out in this context that the Bank of Israel is merely part of a global trend. Most of the central banks in the developed economies are coping with negligible interest rates, and the Central European Bank has gone even further than the Bank of Israel by instituting its own expansionary program. It seems that the desire to maintain exports and contribute to inflation through a combination of low interest and the highest possible foreign currency exchange rate is not confined to the Bank of Israel.
In any case, the Bank of Israel is willing to take the risk that its measure will make housing purchases for investment purposes more worthwhile, because relatively little change is involved. Furthermore, it realizes that in the end, risk considerations in housing prices will also enter the equation, particularly for someone whose investment considerations are in the long term. Even had the Bank of Israel believed that an interest rate cut would affect housing prices, however, it is doubtful whether it would have acted otherwise. Governor of the Bank of Israel Karmit Flug knows that for now, she is alone in the effort to manage economic policy in Israel. There is no Minister of Finance right now, no approved state budget for the 2015 fiscal year, and no one other than she to make decisions of a strategic character for the economy.
Moreover, the increase in activity has boosted tax revenues, while new spending cannot be approved. The result is a budget that has become defensive, and only monetary policy can help push the economy up the hill in the coming months.
Published by Globes [online], Israel business news - www.globes-online.com - on February 24, 2015
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