Interest Slashed to Record Low

The Bank of Israel yesterday confounded analysts with a quarter-point rate cut, to 0.75%, the lowest level in Israeli history. But economists had largely expected Governor Stanley Fischer to take the bolder move of cutting the central bank's overnight rate for March by half a percent. Some had even surmised that he might lower the Israeli rate by 0.75% to just a quarter-percent.

The Bank of Israel itself explains that interest is already close to zero. When you're driving a heavy truck and need to stop, you don't use the hand-brake and stop on a dime, one central bank official quipped. You brake gradually, first by 0.25%, then by another 0.25%.

Ori Yehudai, leader of the Frutarom essences maker and also of the economic forum at the Manufacturers Association, applauded Fischer's moves and called on him to continue lowering interest rates in the months to come.

Uriel Lynn, president of the Chambers of Commerce, was less adulatory, saying that the low interest rate is hurting savers. But Yehuda Talmon, president of Lahav, an umbrella organization for the self-employed, came to bat for Fischer.

"At this time, in the absence of clear fiscal policy to contend with the recession, the governor is doing the best he can using monetary tools to cope with the slowing [economy] and [falling prices]. We can only thank him for it," he said.

Fischer could decide to shave the rates some more in the months to come, or not. Its decision will depend on the effect of lowering interest below 1% on savings and on the banks' margins. It is entirely possible that the general public will feel interest on bank deposits is too low to attract them and will start stuffing cash into mattresses again.

In another move designed to help the banks, in parallel with its rate cut, the Bank of Israel narrowed the interest rate corridor on its resources.

Bank of Israel interest is the basis on which it charges banks when they borrow money from it, and it's also the basis for the rate it gives banks on their deposits.

When banks have surplus liquidity, they deposit it for the night at the Bank of Israel. Until yesterday, the Bank of Israel gave them its rate - 1% - minus the corridor, which had been 0.5%. Now it's narrowed the corridor to 0.25%. So, the Bank of Israel will give them 0.75% minus the halved corridor, which is 0.25%.

That means before the rate cut, the banks had received 0.5% on their deposits. They will still get 0.5% even though the basic Central Bank rate is lower. That is good news for the banks.

The corridor works both ways. The narrower corridor also means the banks will pay lower interest rates on overnight loans from the Bank of Israel, 1% instead of 1.5%.

Ron Eichel, chief economist at Meitav, comforted colleagues who might have been embarrassed at missing out yet again with the thought that in effect, with the corridor trick, Fischer did lower lending rates by 0.5%.

As explained above, the Bank of Israel lowered its rate to banks by 0.25%. But by narrowing the corridor the banks essentially lowered its rate to the banks by half a percent to 1% (the 0.75% basic rate plus the halved corridor of 0.25%).

From September 2008, the governor has lowered the central bank rate by 3.5%, from 4.25% to the rate for March, of 0.75%. Following the quarter-percent cut to the rate at which they borrow from the Bank of Israel, the commercial banks should lower the rate on overdrafts by the same 0.25%.

The Bank of Israel lists three reasons for its rate cut. The first is that the global economic crisis is depressing global demand for Israeli commodities, Israeli economic growth, and Israel's GDP.

At present the Bank of Israel is predicting that the economy will contract by 0.2% in 2009. (UBS is predicting that Israel's economy will contract by 1.1% this year.)

The second reason is that in the last 3 months, inflation has dramatically diminished, and it's expected to fall further. Seen over the last 12 months, inflation is lower than 1%, which is lower than price stability, as defined by the Israeli government. "In the last twelve months the CPI rose by 3.3%, and in the last three months it fell by 1.2%," the central bank said in its announcement.

Thirdly, central banks around the world have been hacking at their interest rates in a desperate drive to jumpstart their respective economies.