Ominous omen: Israel cuts rates
The move by Israeli central bank governor Stanley Fischer, a renowned monetary policy prophet, sugggests further rate cuts across EM
The BoI presser didn't mince its words in justifying the decision by stressing the severity of the economic headwinds:
- The indicators that became available this month show that the slowdown in activity and in demand that started during the second half of 2011 continues. The slowdown in growth of Israel's economy is seen in exports and in domestic demand, against the background of weakness in the global economy and the significant uncertainty existing in the global environment, primarily around Europe. In addition, surveys of expectations, both of consumers and companies, show that the slowdown in the rate of growth is expected to continue.
- Data on economic activity in Europe are consistent with the assessments that the eurozone will slip into a recession in 2012. Figures of actual global trade show a continued volume decline in October. Forecasts for world trade growth in 2012 were revised downward.
...The Bank of Israel expects the rate of inflation over the previous twelve months to remain within the target inflation range in 2012. Forecasters' inflation predictions for the coming twelve months and inflation expectations measured from the capital market are close to the midpoint of the target range.
The risk of default of some European countries as reflected by the high yields on their bonds and their high CDS spreads were expressed this month in the downgrading of the sovereign credit rating of major European economies. Some optimism has been evident recently in global financial markets, primarily against the background of steps taken by the ECB, but uncertainty regarding the debt crisis remains high, which also affects the level of uncertainty about developments in the Israeli economy.
- Interest rates in the major economies are low, and the markets are not pricing in an increase in the interest rate in the coming year in any of the central banks of the large advanced economies. The Fed, it will be recalled, declared that the federal funds rate will remain at a near-zero level till mid-2013 at least. The Bank of England and the ECB continued their efforts to increase liquidity.
Before the rate cut, opinion was divided. A Bloomberg survey found 11 of 20 analysts predicting that the Bank of Israel would hold the benchmark rate at 2.75%, with nine analysts predicting a 25bp reduction.
To understand importance of the cut, its important to note that Fisher has been eerily ahead of the monetary curve in recent years, most recently in September 2011, when the governor cut rates despite domestic protests over house price inflation.
But the story runs deeper. In October 2010, Emerging Markets bestowed upon Fischer the accolade of Central Bank Governor of the Year for the Middle East, citing the former IMF deputy managing director's ahead-of-the-curve policy, pre and post-Lehman:
|In September 2008, as the western financial system imploded, Israel was shielded from the storm, as Fischer had already deployed his razor-sharp instincts and taken pre-emptive action. Between July 2007 and March 2008, as the US investment bank Bear Stearns began to falter, the central bank stepped up its acquisition of foreign currency reserves and snapped up long-term government debt.
When the global crisis erupted in September 2008, Israelis brought their money onshore, causing huge appreciation pressures on the currency. Thanks to the increase in the central banks firepower, with reserves rising from $28.5 billion to $61.2 billion between March 2008 and October 2009, it intervened to weaken the shekel. This ensured the export sector was not ravaged by an uncompetitive currency.
Fischer also blazed a trail by cutting Israels benchmark interest rate by half a percentage point on October 7, 2008 a day before his counterparts in the US, UK and eurozone embarked on coordinated interest rate policy cuts to save the financial system from collapse.
Fischer then cut the rate to a record low of 0.5% by April 2009 and embarked on quantitative easing.And then in August 2009, Fischer became the first central bank governor to hike interest rates as signs of a tentative global recovery emerged.
As a thesis adviser to a young Bernanke and an extremely respected figure in global policy circles - even though his bid to become IMF managing director last summer ultimately proved unsuccessful - Fischer's monetary policy moves are watched with a rare intensity.
Given Fishers intellectual pedigree and on-the-money policy moves, the decision to cut rates highlights the severity of the risks posed by the eurozone crisis and will only add to the consensus view that central banks are set to combat the storm with interest rate cuts.