Bank of Israel May Cut Base Rate to 0% Monday

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Bank of Israel Governor Karnit Flug, June 2014.Credit: Michal Fattal

Israel may be enjoying a 0% interest rate next month – not to mention a return to a policy of quantitative easing for the first time since the global economic blowout in 2009 – when the Bank of Israel monetary committee meets on Monday.

Many economists predict the central bank will take that approach as it grapples with a slowing economy and very low inflation. Yields on short-term notes (Makams) also reflect expectations for a rate cut to 0.1%, a notch above zero.

“Bank of Israel Governor Karnit Flug has proved to be a woman of action, lowering interest rates month after month, so we’re expecting a further rate cut to 0.15%,” said Itzik Noy of Smart Capital.

If Flug and the committee don’t lower the base lending rate, which is already at a record low 0.25% after back-to-back cuts over the summer, they will probably act in December, economists said on Sunday.

Launching a program of quantitative easing, as Flug has signaled in recent media interviews, would be just as dramatic. The last time the Bank of Israel engaged in QE was in 2009 when global financial markets were teetering on collapse and the United States and other economies were poised to enter the deepest recession in eight decades.

The central bank could engage in QE in one of two ways – by buying government bonds from the public as a way of injecting more liquidity into the economy or by stepping up purchases of foreign currency as it has been doing in a bid to weaken the shekel.

Behind the Bank of Israel’s strategy is a concern about a slowing economy and low inflation, perhaps even deflation.

The Central Bureau of Statistics last week forecast that Israel’s economy would grow just 2.2% this year, a sharp drop from 2013’s 3.2% and the slowest pace since 2009.

Inflation was a negative 0.3% in the 12 months through September, and an even steeper negative 1.2% without housing prices. Bond yields point to inflation over the next year of just 0.9%, below the government’s target range of 1% to 3%.

Overseas, the International Monetary Fund cut its global economic growth forecasts for the third time this year earlier this month, warning of weaker growth in core euro zone countries, Japan and big emerging markets like Brazil. In its World Economic Outlook report, the IMF predicted global growth at just 3.3% this year and 3.8% in 2015.

Many economists worry that neither lower interest rates nor QE will have the impact the Bank of Israel hopes for. They contend that the required policy tools are with the Finance Ministry, using a more expansive fiscal policy.

But not everyone believes the Bank of Israel is making the right decision. Zvi Stepak, CEO of investment house Meitav Dash, said the bank was wrong in worrying that the economy was slipping into a recession. Reducing the base rate to zero or close risks higher prices for bonds and other assets – most worryingly homes – he warned.

“There’s no need to reduce interest rates, but even more importantly, there’s no need to purchase government bonds, as the Bank of Israel did in 2009,” he said. “Back then, global and local economic conditions were very different from now and yields to maturity were far higher than today.”

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