You don't have to be especially skilled to understand the macroeconomic situation of Israel's economy and realize that the Bank of Israel will be forced to lower the interest rate, at least by 25 basis points (0.25%) in the coming months. It is highly possible that the first step will be taken tomorrow in light of the picture being depicted by the latest data.
Two basic facts will be faced by the Bank of Israel Monetary Committee headed by Governor Dr. Karnit Flug. The first and more important is the continued slowdown in the economy that was clear even before the latest armed conflict with Hamas. The Composite State of the Economy Index fell just 0.1% in June even before a single rocket had fallen on Israel, industrial exports and output are shrinking, and private consumption shows clear signs of weakness.
The second fact that should influence the interest rate decision is the expected rate of inflation, which is likely to be between 1.3% and 1.5% this year, well below 2% and very near the bottom of the official government target range of 1-3%.
These two factors provide the Bank of Israel with all the required reasons to decide on lowering the interest rate, and it is difficult to suppose that it will let the slowdown continue without trying to confront it. Two more factors may also sway the Monetary Committee the need to weaken the shekel although to be fair it is unlikely that a 0.25% drop in the interest rate or even 0.5% would help devalue the local currency. If a war is not weakening the shekel, a lowering of the interest rate is unlikely to do the job.
It can be assumed that hesitation over lowering the interest rate, if there is any, comes from the housing market. At the moment there is a respite in the rising market while the public awaits the 0% VAT plan in order to charge on the market. But that is only a temporary situation. The Bank of Israel would not want to add upward pressure on home prices. But on this matter the Bank of Israel can rely on the administrative restrictions it has placed on mortgage takers, and if necessary it can make them even stricter.
It should be remembered that the significance of an economic slowdown is in harming the ability of households to repay mortgages. This should prod the Bank of Israel into lowering interest rate to help activity because anyway a slowdown will significantly cool mortgage demand.
The bottom line is we expect the interest rate to fall in the coming months by one or two degrees. With an outlook boding zero interest an effective monetary policy must be managed with all the significance that a slowdown means. The Bank of Israel is caught in a complicated situation and must cope with an environment of uncertainty that is only likely to deepen.
Published by Globes [online], Israel business news - www.globes-online.com - on July 27, 2014
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