Bank of Israel Cuts Key Rate to 0.1% to Help Economy Cope With Coronavirus

It will also provide loans to banks for a term of three years, with the goal of increasing the supply of bank credit to small businesses

Avi Waksman
TheMarker
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Shuttered shops and an empty street amid the coronavirus crisis in Mea Shearim neighborhood of Jerusalem, March 31, 2020
Shuttered shops and an empty street amid the coronavirus crisis in Mea Shearim neighborhood of Jerusalem, March 31, 2020Credit: RONEN ZVULUN/ REUTERS
Avi Waksman
TheMarker

Facing an economy expected to contract more than 5% this year, the Bank of Israel said on Monday it was lowering its benchmark interest rate to 0.1% from 0.25% in its first rate cut in five years. It said it was buttressing the cut with two other measures aimed at mitigating the effects on the pandemic. 

In the first, the Bank of Israel said it would for the first time ever provide up to 5 billion shekels ($1.4 billion) in three-year loans to banks with a fixed interest rate of 0.1%. The goal, it said, was to increase the supply of bank credit to small businesses as they struggle with an economy paralyzed by lockdown.

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Haredi leaders learn harsh corona lesson as Israel sends in the troopsCredit: Haaretz

In the second, the central bank said it was expanding its repo transactions so that they can include corporate bonds, in addition to government bonds, as security. A repo, short for repurchase agreement, is a form of short-term borrowing, which the Bank of Israel began in mid-March.

“The reduction of the interest rate to 0.1% will lead to an immediate reduction, even if small, in the costs of credit for households and businesses, and will support the recovery of economic activity in the exit from the crisis,” Bank of Israel Governor Amir Yaron said in published remarks.

“This is a required step in view of the magnitude of the real adverse impact suffered by the economy, and it complements the other steps we decided on,” he said.

The bank’s dramatic moves come as Prime Minister Benjamin Netanyahu imposes increasingly draconian lockdowns that have brought almost all economic activity to a standstill. As the Bank of Israel was making its announcement, ministers were debating whether to impose a complete lockdown during the Passover holiday that starts Wednesday night.

Yaron said the central bank was operating to a large degree in the dark due to a lack of real-time economic data. However, he cited a central bank analysis which estimated that at the end of March, economic output equal to 37% of gross domestic product had shut down and private consumption had contracted 27%. He estimated Israeli GDP declined 5% in the first quarter.

The Bank of Israel’s measures are in line with those being taken by other central banks dealing with the coronavirus epidemic. Still, the drama surrounding the decision was undeniable. 

The monetary policy committee met by video conference, a situation Yaron described as one “we would not have imagined but that in recent weeks has already become familiar to all of us.”

Yaron had said less than two weeks earlier that there were no imminent plans to reduce interest rates, and that the bank had expected an economic contraction of no more than 2.5% this year, assuming the crisis ran its course by the end of April.

Economists polled by Reuters right before the decision had been evenly split on what the Bank of Israel would do, with six predicting no change in the interest rate and the other six correctly projecting a 15-basis-point reduction to 0.1%.

On the Tel Aviv Stock Exchange a rise in share prices accelerated after 4 P.M. local time when the central bank announced its measures and the rate cut, leaving the bourse’s TA-35 index ending 4.9% higher for the day. 

The dollar and euro had been weakening against the shekel all day Monday and the trend continued in after-hours trading. In the early evening the dollar was at 3.5852 shekels and the euro at 3.8669, versus representative rates set before the announcement of 3.627 and 3.9206 shekels, respectively. 

Side by side with the rate cut and other measures, the Bank of Israel released a revised estimate for the economy that sees a bleak 2020 but a gradually accelerating recovery over the course of the second half and into the year 2021.

Bank of Israel economists forecast that the economy would contract 5.3% this year but recover much of that lost growth the following year when it grows 8.7%. Before it does, however, the unemployment rate for Israelis aged 25-64 will peak at 8% in the second half of 2020. The average annual figure will reach 6% this year, up from just 3.3% in 2019, and remain a relatively high 5.5% in 2021.

Meanwhile, the government’s efforts to keep the economy afloat through 80 billion shekels of grants, loans and extra spending announced last month, together with a drop in tax revenues, will cause the budget deficit to balloon to 11% of GDP, with the ratio of debt to GDP climbing to 75%, both due to the rising deficit and the contracting economy.

In fact, the bank indicated that its outlook right now contains considerable downside risk. Its forecast, it said, assumed that the government would take no other lockdown measure beyond those in force as of Sunday and that restrictions on economic activity would be lifted by the end of June.

“A deferral of a month in the process of removing the limitations, compared with the assumption at the basis of [our] forecast, and a contraction of 15% in world trade, would result in our assessment to a sharper contraction of GDP in 2020 of about 8.8% and will add about two percentage points to the average unemployment rate in 2020,” the forecast warned.

The three-year loan program will operate until the end of May. Under it, loans to commercial banks will be conditional on their lending the money to small businesses based on pre-set criteria. The Bank of Israel said the program would cause effective interest rates for them to drop further than the rate cut alone could do.

The repo program, it added, would mainly come to the help of bigger businesses.

With reporting from Reuters.

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