BoI braces for 0% rate

Fischer says the central bank will need to resort to unconventional measures to cope with the effects of the global financial crisis.

Stanley Fischer nice 88 248 (photo credit: Ariel Jerozolimski)
Stanley Fischer nice 88 248
(photo credit: Ariel Jerozolimski)
As the interest rate nears zero percent, the central bank will need to resort to unconventional measures to cope with the effects of the global financial crisis, Bank of Israel Governor Stanley Fischer said Thursday. "At this point we are considering expansionary monetary policy tools as we are nearing zero-percent interest rates, such as quantitative easing, the purchase of bonds or intervention to ease the credit markets," he said in Tel Aviv at the first annual conference of the central bank's Information and Statistics Division. The Bank of Israel has left the door open for additional interest-rate cuts. There is a consensus among investment houses that the central bank will cut interest rates from its current level of 1% to 0.75% or 0.5% at the next rate decision on Monday. Fischer emphasized that at this stage there was no monetary expansion, since the central bank was still pursuing a sterilization process. "If the interest rate reaches zero we will stop the sterilization," he said. Sterilization is a form of monetary intervention in the foreign-exchange market, whereby a central bank attempts to manipulate the value of one domestic currency relative to another. In the case of Israel, the central bank has been buying dollars to shore up its foreign-currency reserves to weaken the shekel. "We are getting close to the target of 40 to 44 billion shekels that we set ourselves when starting the purchase plan last year to shore up our foreign-currency reserves," Fischer said. "We will soon need to make a decision whether to continue with the dollar-purchase plan." This week the central bank announced plans for the purchase of government bonds to boost liquidity and ease the credit crunch, which raised some criticism in the market. In a recent report, Shlomo Maoz, chief economist at Excellence Nessuah Investment House, said the move might lead to inflation by a rise in the money supply at a time of an economic downturn. "The central bank's strategy may lead to the next bubble," he told The Jerusalem Post on the sidelines of the conference. In response to the criticism, Fischer said the central bank was not printing money by buying already issued bonds and that the inflationary effect would be a necessary result of monetary policy. "Inflation has been dropping very fast and will be too low this year, that is, below the target range," he said. "Our role is to bring inflation back into the price stability target range of between 1% and 3%. "Negative inflation is not good for the economy. This year and in January 2010, inflation will continue to be below the target range for the preceding 12 months," Fischer said. He said the 12-month inflation rate was falling rapidly since October 2008 from 5.5% to an expected minus-0.4% in October 2009. Fischer reiterated his concern over the prospect an expansionary fiscal policy in light of falling tax receipts, a slowing economy and rising debt, urging the new government to maintain fiscal discipline and spending limits. "The budget deficit is already expected to reach 5 percent of GDP on the assumption that the government will keep the expenditure ceiling of 1.7% of GDP," he said. "We don't have the flexibility to increase deficit spending to 10 or 12 percent of GDP like the US to mitigate the effects of the crisis because of our debt situation. If budget discipline is not kept, interest rates will rise to a level the Finance Ministry will not be able to cope with." Fischer said the public-sector debt-to-GDP ratio was likely to rise to 82% in 2009 from 77.6% a year earlier, following a steady decline in recent years. Commenting on the state of the local banks, he said although the Israeli banking sector was not in a crisis, the economic climate was still posing challenges. "We have not yet come to the bottom of the crisis," Fischer said. "The banks still face challenges. This is not the time to make concessions to the capital-adequacy ratios demanded of the banks."