During the halcyon days of 2010, when it seemed that the risk of a global recession was fading, Governor of the Bank of Israel Prof. Stanley Fischer was the first central bank governor of an industrialized country to raise interest rates. Fischer decided that the biggest risk to the Israeli economy was overheating, and talk began about a real estate bubble.
Unsurprisingly, Fischer is now the first central bank governor of an industrialized country to again cut their interest rate amid rising worry about a new global slowdown. Fischer's conduct is strongly reminiscent of his conduct in early 2008, when concerns first arose about a recession ahead of the financial crisis that erupted later in the year.
What is a bit surprising in Fischer's decision yesterday to cut the interest rate by 25 basis points is that Israel's macroeconomic figures ostensibly give him wide maneuvering room and he could have waited before cutting the interest rate. For example, Israel's GDP growth is much stronger than in other developed countries. Even taking the expected slowdown into account, the Bank of Israel predicts 3.2% growth, compared with negligible and even negative growth in the US and Europe.
Israel's inflation and exchange rate figures also gave Fischer the chance to delay an interest rate cut, had he wanted to do so. Inflation is still fairly high, and the best-case scenarios still mention 2% annualized inflation, in the middle of the government's 1-3% target range. The shekel has been weakening in recent weeks, reaching NIS 3.70/$, so Fischer will have to deal with this issue in the short term.
Nonetheless, Fischer decided that he cannot wait with an interest rate cut, thereby signaling that Israel, and the whole world, are liable to go three years backwards to 2008, when his fears materialized in the aftermath of the collapse of Lehman Brothers.
The parallels between the two periods is worrisome, especially when Fischer's remarks then are compared with his remarks now. The similarity is too great to the point that more interest rate cuts cannot be ruled out if the risk of recession rises.
It is also necessary to take into account the experience that Fischer and the Israeli economy gained in the past few years. In effect, Fischer knows that the Israeli economy performed quite admirably in the previous crisis, and he apparently learned quite a few lessons from the events of 2008-09.
It can be assumed that Fischer's opinions were strengthened at the IMF and World Bank Annual Meeting last week. The direct contact with the deep fear characterizing the global economy strengthened his feeling that it is necessary to prepare Israel for a period of instability that is liable to fall into a global recession.
Fischer is presumably constantly reviewing the condition of Israeli banks and the budget. These are, in his opinion, the key to success three years ago, and they need to be the foundation for economic stability if the worst comes to pass in Europe. Banks' capital adequacy ratios and liquidity, together with fiscal soundness will be the factors the will enable Israel to deal with the threats to domestic growth. He believes that cutting the interest rate can help only if these other two factors are secured.
Published by Globes [online], Israel business news - www.globes-online.com - on September 27, 2011
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