Governors of the Bank of Israel often get a chance to make a "historic interest rate cut", since their terms of office are long and they do not have to stand for reelection. As a result, circumstances always arise that require an expansive monetary policy, in which the interest rate becomes the weapon of Armageddon to save the economy and put back on the path of growth.
Governor of the Bank of Israel Prof. Stanley Fischer's two predecessors both had their chance to make this history. David Klein's came in December 2001, when he slashed the interest rate by 200 basis points, and Jacob Frenkel's opportunity came in July 2001.
Most capital market sources predict that Fischer will cut the interest rate by 75-100 basis points tomorrow evening from the current 2.5% to 1.5-1.75%. If he does so, it will be the largest single interest rate cut he has made since taking up office in 2005.
Fischer appears to have every reason for making his historic cut. The 0.6% drop in the November Consumer Price Index (CPI), which slashed 12-month inflation expectations by a full percentage point at a single blow, was just the beginning. 12-month inflation expectations are now negative, i.e. the economy is in deflation as a result of the slump in both domestic and export demand caused by the global economic crisis and reduction in value of the public's financial assets.
Last week, Fischer told the media that he would do everything necessary to fight deflation, and with this one sentence condemned inflation to the pages of history and set the Bank of Israel a new enemy, which can only be fought by cutting the interest rate.
Fischer cannot ignore the actions of his former student and current colleague, Federal Reserve Board Chairman Ben S. Bernanke, who cut the Fed rate by 75-100 basis points to a range of 0-0.25%. An unintentional consequence of his act was to force Fischer's hand to take similar action.
Bernanke needs a weak dollar, but Fischer wants a weak shekel. Israel's current and expected exports situation means that the Bank of Israel cannot allow a shekel appreciation that will hurt exporters, whose income is already falling. Although the shekel-dollar exchange rate last week rose from NIS 3.67/$ to NIS 3.88/$, part of the reason is traders' expectation of a shekel interest rate cut.
Meanwhile, figures continue to arrive at the Bank of Israel showing falling exports, industrial output, trade and services proceeds, and retail sales. Only unemployment is rising.
In interviews with the foreign media, Fischer was no longer willing to say that there was no recession in Israel. Just a few months ago, the word "recession" was taboo. But Fischer noted that the government failed to pass the 2009 budget or the economic stimulus plan. The government is paralyzed and will remain so at least through mid-2009, with the result that the "burden falls on the Bank of Israel".
This is the main reason why the pending interest rate cut is so needed. The government is paralyzed, there is no budget, no stimulus plan, and until after the elections and the formation of a new government, the economy has only Fischer and the interest rate. It is the sole effective weapon remaining to fight the crisis, and as he has pointed out, "The crisis won't wait for us."
Last week, Fischer unveiled a monetary plan to increase liquidity in the economy and enable the banks to translate the lower Bank of Israel interest rate into lower interest rates for the business sector. The point is arguable. Some economists believe that an immediate and sharp interest rate cut is warranted; others believe that a sharp interest rate cut is pointless because the problem is risk, not liquidity, and the banks will continue keeping their interest rates high. Whichever argument is correct, Fischer may decide to hold off on his history-making interest rate cut for two or three months when the economy is already is a deep slowdown.
Published by Globes [online], Israel business news - www.globes-online.com - on December 28, 2008
© Copyright of Globes Publisher Itonut (1983) Ltd. 2008