Bank of Israel Cuts Interest Rate to Lowest Level in Local History

Fischer cut the central bank rate by 0.5% to 3.25%, explaining that the cut was necessary to keep prices stable.

Bank of Israel Governor Stanley Fischer yesterday lowered the central bank interest rate to its lowest level ever, confounding analysts' forecasts of a much milder monetary move.

Fischer cut the central bank rate by 0.5% to 3.25%, explaining that the cut was necessary to keep prices stable. The Bank of Israel's main mandate is to maintain inflation expectations within a target range of 1% to 3%. Yesterday's move reduces the prime interest rate from 5.25% to 4.75%.

Fischer's dramatic move was a great surprise to the analyts. Until last Thursday, Jerusalem circles and brokers alike were confident that the Bank of Israel would indeed lower interest rates for April by half a percent - which Fischer indeed did. But then Fischer sprung a huge surprise, by announcing that the Bank of Israel would, from yesterday, begin to buy $25 million-worth of dollars on the foreign currency market every business day, in order to build up Israel's foreign currency reserves by $10 billion over two years.

Analysts immediately leaped to the conclusion that Fischer was attacking the strong shekel, which has appreciated by about 12% against the dollar this year, from two directions: through intervention in trade, and through interest rates. And once he had announced the decision to buy dollars, they surmised that Fischer would elect for cautious moves on interest rates, and would lower the central bank rate by only a quarter-percent. Well, he didn't.

Economists also misread the governor last month, predicting a modest rate cut of 0.25%, while in fact, he cut interest rates for March by 0.5%.

Inside two months, then, Fischer has lowered the central bank rate by a full 1%, to its lowest level in Israeli history. Even at 3.25%, interest on the shekel is firmly above the 2.25% interest rate on the dollar. The fact that foreign investors remain so avid regarding local investments attests to the allure of the shekel and of the local economy. Israel has come a long way since an interest rate gap in favor of the dollar was unthinkable.

Yesterday's rate cut and Fischer's decision to reverse tack and intervene in the forex market - the Bank of Israel bought $600 million in two days - are designed to sustain brisk economic growth and reduce damage to exporters. They also show that Fischer is a new type of central bank governor for Israel: He has a broad view, he knows the history of economic crises and how they were resolved. Fischer is also a creative and daring economist who does not shrink from radical solutions, and while like all other governors, his top priority is stable prices - he clearly believes that in times of crisis, flexibility is the ticket. In the future, his policies will be the stuff of Economics 101.