7 reasons to lower the interest rate

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7 reasons to lower the interest rate

Most analysts believe the Bank of Israel will keep the interest rate for October unchanged at 1.25%, but there are seven reasons why it may spring a surprise.

22 September 13 14:06, Adrian Filut
Although most analysts believe that the Bank of Israel Monetary Committee will keep the interest rate for October unchanged at 1.25%, for the fifth consecutive month, there are seven reasons why the committee may decide to spring a surprise and cut the interest by 25 basis points to 1% at Monday’s meeting.1. The problematic growth mix

Last week, the Central Bureau of Statistics published a forecast which predicts a further slowdown in the growth rate in 2013 to just 3.4%. The data point to a drop in imports, stagnation in exports, and plunge in investment in economic sectors and in construction. In other words, the low growth in 2013 was based on government support and private consumption, which is already beginning to grind to a halt.

2. A very low inflationary environment

The Consumer Price Index (CPI) rose by just 0.2% in August, the lowest level for this month in five years. Were it not for the housing item (rent), it could be said that there is no inflation in Israel. Moreover, capital market 12-month inflation expectations have for months been around 1.5%, well below the 2% midpoint of the price stability target. In other words, the low inflation environment support an interest rate cut.

3. Developments in the exchange rate

The shekel-dollar exchange rate has plummeted in the past couple of weeks, mainly because of the cancellation of a US attack on Syria. On Friday, the shekel-dollar exchange rate fell to nearly NIS 3.50/$. The shekel has strengthened 3% against the Bank of Israel’s basket of currencies in the past month, and, more importantly, the current accounts in the balance of payments, which measures dollar inflow and outflow, indicates substantial improvement, from a deficit of $1.5 billion in the first quarter of 2012 to a surplus of $2 billion in the first half of 2013. All this also supports an interest rate cut.

4. Improvement in the fiscal picture

The substantial improvement in the fiscal picture gives more room for monetary expansion, or at least, does not prevent it. According to the Ministry of Finance, the government deficit in August fell 55.5%. The deficit fell 41% to NIS 12.9 billion in January-August 2013 from NIS 17.6 billion in the corresponding period of 2012. In addition, the change in the Central Bureau of Statistics’ methodology for calculating GDP ensures a decline in the deficit, and especially the debt.

5. Bernanke’s message

Support for cutting the interest rate also comes from overseas. Belying all forecasts, last week, Federal Reserve Board Chairman Ben S. Bernanke did not taper off the quantitative easing 3 (QE3), sending a clear message: the US economic situation has improved, but it is still not good enough, especially in the labor market, to end or reduce aggressive monetary expansion. In other words, things are not yet back to normal. Such a message will support, and especially give inspiration to, Acting Governor of the Bank of Israel Karnit Flug and her colleagues.

6. Flug’s last act

This will be Flug’s last interest rate decision as acting governor, and maybe even as a member of management at the Bank of Israel, as she is expected to leave when the next governor takes office. Prime Minister Benjamin Netanyahu and Minister of Finance Yair Lapid will reportedly decide on the next governor immediately after the Sukkot holiday. After so many years at the Bank of Israel, Flug will want to leave her mark and make a more substantive decision.

7. The housing item will have no effect

Although the housing item (rent) in the CPI will continue to climb, it will have no effect on decision-making at the Bank of Israel. A few weeks ago, it took additional extreme measures to greatly restrict mortgages, and indicated its intent to use other, non interest rate, tools to deal with the housing market. The Bank of Israel has also repeatedly made it clear that the government is responsible for solving the issue of home prices, in other words, by dealing with the supply side, not the demand side.

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