Israel can't escape subprime woe
Economic growth is going to be a lot slower than originally expected this year, possibly about 2%.
No, Israel is not immune to the subprime crisis. As its ripples shake world markets, Israel too will feel its effects, predicts the Bank of Israel. Economic growth is going to be a lot slower than originally expected this year, possibly about 2%, compared with 5.5% in 2007, the central bank says. In terms of growth per capita, that's stagnation (because the population is growing at roughly that rate).
If the scenario of slower growth materializes, the central bank's interest rates may be brought down even further, warned deputy governor Zvi Eckstein on Sunday.
That dire scenario explains the aggressive steps the Bank of Israel has been taking lately, to the general shock: intervening in the foreign currency market, once unthinkable, then done, then a policy of buying about $25 million every business day for two years, and the half-percent interest rate cut to the lowest level in Israeli history - 3.25%. These are expansionary measures that run the risk of exacerbating inflation.
The central bank is unworried about an inflationary outbreak because an economic slowdown (which means slower growth; recession means persisting negative growth) would counter the inflationary pressures resulting from the interest rate cuts or forex meddling.
In fact, "Even a temporary deviation above 3% inflation doesn't worry us," Eckstein says. The central bank believes that by September, inflation will be back inside the target range, which is 1% to 3%, he explains. For the year, inflation is expected to be roughly mid-range.
The Bank of Israel also expects that inflationary pressures coming from the outside will abate. Inflation today is about 3.6%, says Eckstein, much of which is because of the rising prices of commodities and food in the world. Without their impact, local inflation would be about 2%, he says. Moreover, the central bank believes that the dollar's weakness has halted the upward spiral of commodities and food.
Also, at home, the shekel's dramatic appreciation has eroded the prices of imported goods, which is a reversal from the situation of late, Eckstein says.
If the Bank of Israel had thought it possible that its forex intervention or interest rate cuts would compromise its main goal of keeping inflation in check, it wouldn't have done them, Eckstein says. "It's true that the governor ascribes more weight these days to events in the world on domestic growth," he acknowledges what analysts had been surmising. But there hasn't been any fear that inflation will spiral out of control, he adds.
Monetary policy can claim a great achievement: Inflation has remained roughly within the boundaries of price stability, meaning 1% to 3%, for years and years, Eckstein points out. That freed the central bank to serve the needs of economic growth as well, but at no point did it lose its goals, which remain in the new Bank of Israel Law too. Its job is to encourage economic growth and employment, but only subject to keeping prices stable, Eckstein says.
And if Israel does sink into true recession? Might the Bank of Israel lower its lending rates even below their currently record nadir of 3.25%? It certainly isn't about to do that right away, Eckstein says. First the central bank has to see whether its dire forecasts come true. The consumer price index for March is expected to be very low, but come April the CPI is expected to bound upwards again, and regarding May, the word is pure uncertainty.
Only after those months have passed will the Bank of Israel be in a position to judge and consider another interest rate cut, says Eckstein. For the time being, the rate cut already performed was significant enough.
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