BOI officials concerned lower interest rates won't solve liquidity crunch

Round of rate cuts might have come to an end, officials say.

Stn Fischer good 88 248 (photo credit: Ariel Jerozolimski)
Stn Fischer good 88 248
(photo credit: Ariel Jerozolimski)
Bank of Israel officials are raising concerns over liquidity difficulties in the financial market and a potential switch to high-risk investments by the public as the interest rate is heading toward nearly zero, minutes of the March interest discussions showed on Monday. "In Israel and around the world, questions are being asked regarding the functioning of the financial system when interest paid to depositors is close to zero," stated the participants in the meeting. "In these circumstances, there could be a switch from time deposits to current-account deposits, which would make it more difficult for banks to manage liquidity and to balance deposits and loans. "The public may also switch from bank deposits into other assets, that could create an undesirable increase in risk for savers in the financial system." On February 23, the Bank of Israel cut March interest rates by 0.25 percentage points to a record low of 0.75%. The reduction was smaller than expected by the majority of market analysts, who forecasted a 0.5% rate cut. In the narrow-forum discussion of the interest rate decision, four of the five central bank officials recommended reducing the rate by 0.25%, and the other member recommended a reduction of half a percentage point. The latter argued that it was important to make such a reduction in order to boost growth, among other things by weakening the shekel against other currencies, and that the risks involved in such a cut were not serious. The four participants recommending a cut of one-quarter of a percentage point argued that a reduction in the interest rate should be made in order to encourage economic activity and to improve liquidity in the financial markets. However, they were of the opinion that at this stage a larger reduction was not appropriate as banks had not passed on recent interest rate cuts to businesses and consumers. "At this stage of the economic cycle, it is not clear to what extent further cuts in the interest rate would affect the cost of credit to firms and households, since the banks are maintaining the spread between the average interest they charge borrowers on credit granted and the interest they pay depositors - which is lower than the Bank of Israel's published rate," stated the participants in the minutes of the discussion, adding that the effectiveness of further interest rate cuts had to be examined. In the course of the meeting the participants urged a focus on other unconventional instruments to bring about monetary expansion. On February 17, the central bank started buying government bonds on the Tel Aviv Stock Exchange to support the lowering of interest in the economy in the longer term. Looking ahead, the participants agreed that "if necessary, the central bank would also consider activating other instruments in its arsenal (such as those used by other central banks) to increase liquidity in the financial system, as part of the policy of credit easing or quantitative easing." On Tuesday, Governor of the Bank of Israel Prof. Stanley Fischer is convening a special press conference to discuss the current economic and financial climate and make recommendations on measures to cope with the crisis.