Interest rates

Bank of Israel Gov. Karnit Flug made history last week by slashing the benchmark interest to its lowest ever level.

Karnit Flug
Bank of Israel Gov. Karnit Flug made history last week by slashing the benchmark interest to its lowest ever level – 0.25 percent. This brings Israel significantly closer to key rates overseas, though it still leaves us a marginal tad above them. In the US, the range is between 0% and 0.25%, whereas in the euro zone it’s 0.15%.
This cut is geared to make investment in the shekel less attractive than hitherto, which ought to weaken the chronically overvalued currency and pump up foreign currencies’ values vis-à-vis it.
For one thing, foreign speculators will have less incentive to park their money here to benefit from higher shekel interest rates. This will lower the demand for the shekel and with it its value.
This will make our exports cheaper and more competitive, but will make imports more expensive and increase our cost-of-living. No Israeli can remain untouched by this.
Interest rate adjustments are the last effective weapons left in the BoI’s arsenal and the ammo is all but spent, because it is hard to see Flug going down to zero interest. Even when the global economy wallowed in its great 2008-2009 crisis and central banks hysterically hacked rates, the lowest the BoI went was to 0.5%.
This means that we are at rock-bottom by Israeli criteria.
It is far from certain that this will suffice to revitalize the sluggish economy.
Things were slowing down already before the Gaza conflict flared, mostly because of a worldwide economic dip. This had begun to hurt Israeli exports and the ripple effects caused cross-sector economic listlessness.
Industrial production is steadily slumping, as is growth in the gross national product. Annualized growth in the second quarter (1.7%) was markedly down from the first quarter (2.8%). Last year’s second quarter expansion rate was 5.3%.
The fighting in the south exacerbated extant trends and at this point is estimated to have chipped away another 0.5% of the GNP.
The expense of the military operations will be staggering and cannot yet be reliably quantified. Badly hit are sectors such as tourism there is also the fact that Israelis stayed home more than usual during the summer, shopped less and were in no mood to spend.
This hurt the economy in the same manner that dehydration affects the body during a heat wave. First aid requires urgent transfusion of liquids and this is the treatment Flug administered by cutting rates.
The goal is to induce businesses and householders to save less and spend more, because staying safe is now plainly less profitable. The idea is to put capital back into circulation. Freed-up funds would be redirected into the marketplace and thereby energize it.
This, of course, involves risk, especially for ma-andpa investors who usually prefer very conservative financial strategies. Their alternative for such savers is to dive into the housing or bond markets, both of which are already bubbling dangerously.
Real estate looks particularly alluring because the unprecedented low interest rates renders other investment routes unappealing and means cheap mortgages and cheap loans.
The likely rush into real estate can only fire up an already feverish sector, where prices are high and financing looks uncommonly tempting. This is disconcertingly reminiscent of the American subprime bubble that triggered the international recession five years ago.
Things are not very different in the bond market, where prices are already considered inflated and unrealistic and where it is tempting to float more and more bond issues to raise quick cash without adequate regard to how investors can be assured of getting their money back.
We had already seen too many “haircuts,” that is write-downs in the value of debt owed to investors, in recent months to trust that there is nothing to be anxious about.