The Bank of Israel's key lending rate will go down to 6.3
percent, the lowest nominal rate since the Bank of Israel
was set up in the early 1950s, announced the Governor of the
Bank of Israel David Klein, in reducing the August interest
rate by 0.2 percent.
This is the fourth interest rate cut in two months,
following a 0.4 percent cut in June, and a 0.3 percent cut
in July. Israel's interest rate has been falling for 18
months, in line with trends around the world.
For several years, beginning in the tenure of previous
Governor of the Bank of Israel Jacob Frenkel (now a member
of the senior management of Merrill Lynch, the worldwide
financial services conglomerate), Israel has maintained a
higher interest rate than the rest of the developed world.
This has made its shekel currency strong, raising confidence
in the currency and promoting price stability.
Frenkel and Klein have pointed to the fact that Israel
weathered several international crises without any severe
internal shocks as proof that their policy is effective and
is meeting its goals. Business and political leaders have
complained that the high rates of interest discourage
investment and restrain economic growth.
After the latest move, the gap in nominal interest rates
between Israel and the U.S. now stands at 2.55 percent which
is very high in view of the fact that inflation in Israel is
comparable to that in the U.S. This means that the real rate
of interest, meaning the amount that the interest rate
exceeds the expected inflation, is close to 4 percent in
Israel, a rate that is very high by historical standards.
Klein sees his primary responsibility as fighting inflation,
and his decision is based on assessments that the
government's inflation targets for the next two years may be
met even with lower nominal and real interest rates. The
interest rate decision was apparently also affected by the
worrisome data published yesterday which indicated that the
recession is deepening.
At a meeting with Labor Party Knesset members about two
hours before the publication of the interest rate decision,
Klein said that if inflation goes up, he would halt the
interest rate cuts, and he would not hesitate to raise the
interest rate if inflation expectations begin to exceed the
targets. Current inflation expectations are slightly below
the targets set by the government, according to Klein.
The government's target for inflation stands at 2.5-3.5
percent for the year 2001, 2.0-3.0 for 2002, and "price
stability" thereafter of 1.0-3.0 percent. The bank said its
monetary policy "strives to achieve the inflation targets,
the infrastructure essential for sustainable growth and
continued bolstering of the financial stability that the
economy has demonstrated in the money, capital and foreign
The bank said that this stability had been achieved "as a
result of monetary policy, among other things." It went on
to claim, however, that its policy "cannot provide the means
for offsetting the dampening effect on Israel's economy of
factors such as the security situation in Israel and the
slowdown in the U.S. economy."
Klein called on the government to issue clearly defined
fiscal policies, and called for "greater transparency . . .
including a report to the government and the public on the
estimated budget deficit for 2001, using internationally
The bank stressed the need for the government to keep within
its expenditure limits, and maintain the downward path of
the budget deficit as set out in August 2000. "Any increase
in the budget deficit or the public debt are likely to halt
and even reverse the downward trend of the real rate of
interest in the bond market and the rate of interest on
mortgages," the bank explained. "Such fiscal expansion may
also undermine the prevailing stability in Israel's
markets," the statement continued.
The business community welcomed the cuts and asked for more
of the same. The Manufacturers Association welcomed the cut
in interest rates. The association's economists called for
the governor to continue lowering the cost of borrowing, and
pointed out that even after the latest cut.
Business leaders and politicians have called for lower
interest rates to stimulate the economy. However it is not
clear if this would be as effective as they say. In the US,
the central bank has cut interest rates very sharply but has
not yet seen a significant response to this stimulus. Other
factors such as high energy prices, low stock prices and a
bust in technology investment following several years of
exuberant boom, are keeping the economy sluggish. Israel is
also affected by these factors, in addition to the violence
that has plagued it for ten months. Thus it is not clear
that even a drastic interest cut would do much.