At Governor of the Bank of Israel Stanley Fischer's press conference earlier this month, he spoke about the minimum interest rate, below which it is not possible to go. He quoted Governor of the Bank of England Mervyn King who said that the UK could not reduce interest rates below 1%.
Judging by Fischer's actions, in his opinion the shekel interest rate is very close to its minimum level. As a result, the Bank of Israel will switch to implementing the alternative measures to its interest rate policy, which he spoke about at that same press conference. In effect, we can say that the Bank of Israel is implementing the mental transition to an era of zero interest.
Fischer mentioned three steps, which could assist the management of liquidity in the Israeli economy, and help the credit market recover. The decision of the Bank of Israel to purchase government bonds will help lower long-term bond yields and renew activity in the corporate bond market. Meanwhile, the central bank is preparing to sell short term deposits to reabsorb the money flowing into the purchase of long-term government bonds, so there will be no expansion of liquidity. Thus when interest reaches a minimum, the bank can stop its absorption activities and use bonds purchases to increase liquidity.
The Bank of Israel also announced yesterday that it was the narrowing of adequacy in credit and in commercial bank deposits from 0.5% above and below interest. Again we are talking about an action that will assist in raising liquidity with ramifications for the credit market. In the third stage, the Bank of Israel may purchase private instruments including corporate bonds, if it becomes clear that the other measures did not revive the non-banking credit market.
There is one issue that must be highlighted with regard to the figures on which the Bank of Israel is currently basing its policy. According to the bank's calculations, capital market 12 month inflation expectations are for 0.8%, and the meaning of this is zero real interest.
So what if these expectations are taken from estimates that are lacking the recession and the deflationary pressures on the Israeli economy? The bank itself estimates that the nominal salary in Israel has dropped in recent months, the price of energy and commodities continues to fall and local demand is contracting. Over the past five months the Consumer price Index (CPI) has fallen by 1.2% and if this rate continues, the CPI will fall by more than 2% this year.
The significance of this is that real interest is today close to 3%, if indeed deflation is stronger than the present forecasts. In other words, it is worth the public - both households and companies - to again start thinking of real interest because the reality is likely to be that prices are falling. In the conditions developing in the Israeli economy, it is not only the Bank of Israel that must get used to the new rules of the game.
Published by Globes [online], Israel business news - www.globes-online.com - on February 24, 2009
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