The Bank of Israel Monetary Committee on Monday cut the interest rate to its lowest-ever level, unexpectedly halving it to .25 percent against the backdrop of disappointing economic growth at home, low inflation, a still-limp recovery in Europe and the ongoing war with Hamas in Gaza.
“The path of the interest rate in the future depends on developments in the inflation environment, growth in Israel and in the global economy, the monetary policies of major central banks and developments in the shekel exchange rate,” the committee wrote in its decision.
The central reason given was low inflation, which came in at just .3% over the past 12 months, falling below the 1-3% target.
The ongoing conflict in Gaza, entering its eighth week, has already taken its toll on the economy, but second-quarter growth before the operation began in July was already stalled at 1.7%.
Though the overall impact of the war could not yet be measured, the committee noted that, “an extended negative impact is expected in tourism and a negative impact, apparently temporary, in private consumption.”
Last month, the committee estimated that the war could lop .5% off GDP growth, but that figure was based on an assumption that it would last about as long as the 2006 Second Lebanon War, which ended after 34 days.
The decision to cut the rate in consecutive months and bring it to near-zero levels meant that the bank was acting aggressively, but also that it had few tools left in its arsenal, said Shmuel Ben Arieh, head of research at Pioneer.
“It used all of its interest ammunition in the last two decisions,” he said.
Having a rate on par with the United States would mean that buying shekels offers little upside to foreign exchange traders, he added, meaning the shekel could come off its problematic strong streak.
Psagot Investment’s Uri Greenfeld noted that the interest rate, with little room for further decline, would likely remain low until the US finally begins raising its own rates, expected in 2015. The US has had near-zero rates in place since the onset of the global financial crisis in late 2008.
In Israel, which was the first advanced economy to raise its rates following the crisis, the rate reached as high as 3.25% in September 2011, before starting to come back down.
Despite the shekel’s depreciation in the past week, exporters are still suffering, said Israel Export Institute chairman, Ramzi Gabbay.
“Only a recovery and growth of exports will allow sustainable economic growth and a recovery from the crisis,” he said.
Stagnant growth in Europe, Israel’s largest regional trade partner, also hurt exports, whose drop was a significant contributor to the economy’s lackluster second-quarter performance.
The interest rate will have repercussions for the housing market, too. Lower rates fuel demand among investors and make mortgages cheaper. The low interest rate environment and the lack of sufficient new supply has caused the housing market to heat up, with prices more than doubling in the past seven years, including a 7.7% jump in the past 12 months. The International Monetary Fund has warned of a possible real estate bubble in Israel.
Even amid a transaction slowdown in the housing market resulting from uncertainty over Finance Minister Yair Lapid’s 0% VAT policy rents and prices have continued to rise.