May 26--Monday's interest rate decision by the Bank of Israel Monetary Committee has split analysts. A "Bloomberg" poll found that ten analysts expect the Bank of Israel to keep the interest rate unchanged at 0.75%, and eight analysts expect a cut to 0.5%, equaling the lowest-ever rate of five years ago.
The argument is over tactics, not strategy. Even the analysts who forecast that the Monetary Committee, chaired by Governor of the Bank of Israel Dr. Karnit Flug, will keep the interest rate unchanged, believe that the committee will cut the interest rate in a few months. "We are not living in normal times, nor are we nearing them," said Flug at a conference in Tel Aviv last week.
The Bank of Israel has all the empiric data to cut the interest rate now. Inflation over the past 12 months through April is just 1%, the bottom of the government's price stability target; the Bank of Israel's Composite State of the Economy Index, published today, shows stagnation for the past two months, which has not happened since April 2009; GDP grew by only an annualized 2% in the first quarter, the lowest rate since the first quarter of 2009; GDP per capita fell by an annualized 4%; and investment in fixed assets fell by an annualized 14%.
There are arguments in favor of keeping the interest rate unchanged. First, the Monetary Committee has just one bullet left; i.e. it can make only one more cut in the interest rate, and this ammunition should be held in reserve, especially when inflation is so low and the direction of economic activity is unknown. There is also the argument that an announcement of a worsening of the slowdown should be put off for a few months, given that the Central Bureau of Statistics initially reported 2% growth for the third quarter of 2013, before revising the figure upwards to 3%. Some economists also note that while domestic demand has weakened, export demand has strengthened, thanks to the improvement in the US and European economies.
There are also political factors. The Bank of Israel is trying to pressure the Ministry of Finance to raise taxes to increase public spending without increasing the deficit. The Bank of Israel will not carry out monetary expansion so long as it does not know if there will be a budget blowout. Delaying an interest rate cut could be a tool to pressure the Ministry of Finance, which has not yet officially announced its fiscal policy.
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