Fischer cuts interest rate .25%, analysts cite budget

When Bank of Israel Gov. Stanley Fischer made the surprise announcement on Monday that the bank would drop its benchmark interest rate from 1.75% to 1.5% on Friday, he cited the strengthening shekel, lower interest rates around the world and the new inflow of offshore natural gas to Israel.

The central bank also announced that it would buy up $2.1 billion in reserves through the end of the year to counter currency fluctuations caused by the natural gas, a policy it said it would revisit when a sovereign wealth fund comes online in 2018.

Left unmentioned, however, were the possible economic effects of tax increases and welfare cuts in Finance Minister Yair Lapid’s 2013-14 budget proposal, which the cabinet was set to approve on Monday night.

“The cause that’s missing from the Bank of Israel’s release is the updated growth forecast in Israel in the coming years, in view of the Treasury’s tightening fiscal policy that aims to narrow the structural deficit,” said Uri Greenfeld, who heads the research department at Psagot Investment House Ltd. The cuts, he said, are expected to lop a half-point of GDP growth off of 2014 alone.

Leader Capital Markets estimated the decrease in economic growth at 0.7%.

“If the budget proposal is accepted as it,” said Eran Tazhi, a research analyst at Infinity, it would lead to a “moderation in demand that results from the increase in direct taxes.”

Central banks sometimes use the interest rate to give a lagging economy a boost; lowering the cost of borrowing money makes it cheaper for business owners or entrepreneurs to invest in their businesses.

“Reducing the interest rate will help the business sector in general and small businesses and the self-employed in particular, but monetary policy is not a substitute for government policy that actively initiates encouragement for the business sector,” said Ehud Ratzavi of Lahav, a business association.

A spokesman for the Bank of Israel said that claims of reduced growth are premature, noting that the details of the budget have yet to be finalized. Even with a harsh package of welfare cuts and tax hikes, he said, the budget is overall growing by 7% in real terms, which should have a stimulatory effect on the economy.

“The message we sent out was very precise about the reasons for the decision,” he said.

According to the bank, the shekel effectively appreciated by 2.4% in the past month, and by 5.4% in the past three months. “The shekel’s strength against the dollar and the euro during these periods stood out markedly in comparison with other currencies’ movements vis-à-vis the dollar and euro,” the central bank said.

Alongside lower growth forecasts in China and Europe, the interest rate reduction in Europe and the influx of dollars from the Tamar natural gas field, those factors are expected to further strengthen the stubbornly strong shekel.

“Apparently the Bank of Israel wanted to achieve the effect of a surprise in order to maximize the effect on the foreign exchange market,” Greenfeld of the bank’s early announcement.

After sinking as low as 3.556 to the dollar last week, the shekel closed at 3.571 on Monday.