Interest Rate Cut Changes Strategies for Savings

The Bank of Israel's announcement last week regarding its intention to lower the interest rate in the economy by 2 percent surprised the banks as much as it did their customers. Confusion and bewilderment reigned at bank branches on Friday and Sunday, when it was still not clear if the central bank would lower the interest rate immediately, and by how much. As a result, the banks could not give clients clear advice regarding short-term investment instruments.

"It's worth waiting a day or two," was the prevalent advice at the branches. To be on the safe side, the banks immediately lowered the interest that they pay on fixed interest deposits and recommended variable interest deposits to their clients.

The dramatic move by the Bank of Israel in lowering the interest rate Sunday by 2 percent creates a new situation in the money market and it will be a long time until its real effects become clear, when balance is restored between the various investment instruments and their terms.

The new situation makes it difficult to figure out which investment instrument is more worthwhile than the others. In recent years there were many times when it was better to invest in short-term unlinked shekel deposits (which created the famous mountain of shekels) - but today the interest on such deposits is no longer attractive. The financial system welcomes this fact and feels that the lowering of the interest rate will create a balance between the various investment instruments: unlinked shekel deposits, linked shekel deposits, foreign currency and the capital market.

Two prominent trends that were prominent in the past few years will stand the test of the next few weeks and months: The first is the clear preference for linkage to the cost-of-living index or to the prime lending rate, over linkage to the dollar. The second is the preference for unlinked shekel investments over investments that were linked to the dollar. Bank sources predict that under the present circumstances there will be increased interest in investment tracks that offer a choice - savings products that allow depositors to choose the type of linkage at the end of the savings period - than in other savings and investment tracks.

Shekel deposits

Interest rates have been lowered by 2 percent, effective immediately, so shekel deposits are not as attractive as in the past. On the other hand, the coming days will be characterized by fluctuations in the various markets so investing in a short-term shekel deposit at the moment, until the whole picture becomes clear, is a reasonable solution, given the liquidity that such deposits offer.

In recent years shekel deposits were quite popular for both their high yields and their liquidity. The new situation reduces the attractiveness of yields, but these instruments still retain their liquidity. Another option is to invest in a short-term loan (Makam in Hebrew), which is a type of unlinked bond issued for periods of up to a year. This type of investment offers reduced banking charges and usually provides a higher yield.

Index-linked savings plans

The interest offered on index-linked savings plans will be lowered soon, but by less than 2 percent. This is because the adjustment process for interest rates on medium- and long-term investment instruments takes longer, and is affected by what happens in the bond market.

In the long term, the depreciation of the shekel is liable to cause a rise in inflation and index-linked instruments will provide full protection from the increase in the cost of living. Since the interest in the economy has been low for years, the likelihood that interest rates will be lowered again in the future is less than the likelihood that it will be raised.

In the coming days, we will witness the stabilization of what is called the "normal yield curve" - the situation in which the longer money is left in a savings plan, the higher the yield. This is the normal situation in the investment field, but in the glory years of the shekel the preference was for short-term investments. The key questions are whether the public is already addicted to the liquidity of unlinked investments and whether the public is prepared to give up this liquidity in favor of higher yields.

Foreign currency linkage

Anyone who is afraid of currency depreciation will invest in instruments that are linked to foreign currency exchange rates, but the expected fluctuations in the foreign currency market over the next few days are liable to be disastrous. One could easily end up buying foreign currency when it is peaking, only to find oneself with losses when the market settles down. It goes without saying that the foreign currency market is affected by what goes on around the world, and there are chances that local conditions will be at odds with global trends.

Profits from the differences in the exchange rate of the shekel and any foreign currency are tax exempt, whereas profits on investments (interest) are taxed at a rate of 35 percent. The new European currency, the euro, will be effective starting January 1, so the main foreign currency linkages will be to the dollar and to the euro.

Provident funds

Investments in provident funds are worthwhile at the end of the year for anyone who can benefit from the tax credits. The banks extend loans at particularly low interest rates to clients who are interested in investing in provident funds. Provident funds invest their money in various instruments in accordance with the judgment of the funds' investment managers. If the money in a provident fund is liquid, this type of investment could be a good interim solution. There is a wide selection of provident fund tracks in keeping with fund members' preferences.

Share-oriented mutual funds

The stock market responded Monday to the central bank's decision to lower the interest rate, with sharp increases of 5.6 percent. It is reasonable to assume that the market will continue to fluctuate for several days, in line with the behavior of investors, some of whom will gamble on continued rises. The mutual funds have the advantage of liquidity and a wide variety of investment tracks, a factor that attracted increased interest on the part of the investing public.

If the economy were in good condition, that is to say if economic growth was strong, it would be easy to recommend investing in shares or in share-oriented mutual funds. However, we are currently in a very problematic situation because the economy is in recession, unemployment continues to rise and the government's budget deficit has grown. Under such conditions, investing in shares is still risky, on top of which the companies have not yet issued their financial reports for 2001, which will be worse than those of 2000.

Investing in shares must also be examined on the basis of an analysis of capital markets around the world, particularly in the United States. If the trend on Wall Street is negative, the effect of budgetary and monetary steps in Israel will be secondary.