The Bank of Israel decided Monday to cut its benchmark interest rate to 1.75% - dropping below 2% for the first time since September 2010.
The central bank's Monetary Committee made the decision to lower its key rate by 0.25% after receiving the Research Department's growth forecast for 2013, which was revised downward to 2.8%, compared with 3% in the previous forecast.
The committee members noted in a statement that the decision was made in light of "a continuation of the slowdown in activity, which can be seen in the Composite State-of-the-Economy Index.
"The results of various surveys of activity also indicate continued slowdown. The source of the weakness in activity is apparently related to a slowdown in exports due to weakness in global markets, a slowdown in world trade, and the effects of Operation Pillar of Defense."
Two additional factors supported the bank's decision to lower the interest rate. The bank's inflation forecast has been dropping consistently for several months now, and currently stands at 1.8% for 2013.
In addition, directives from the supervisor of banks limiting the loan-to-value ratio in new housing loans recently went into effect.
Lowering interest rates is generally aimed at encouraging economic activity at times of crisis. On the other hand, in some cases a low interest rate could lead to price hikes, especially in industries requiring a bank loan in order to purchase products, such as the housing market.
The low interest rates in the Israeli economy in 2009-2012 are said to have contributed greatly to the drastic increase in apartment prices after the monthly mortgage payment decreased significantly – encouraging many Israelis to buy apartments.
This time, the Bank of Israel sought to prevent an expected price hike in the housing market by imposing a restriction on mortgage financing before raising the interest rate. In addition, the bank waited for the general inflation forecasts to be below the midpoint of the target range (1-3%).
The Research Department's growth forecast, which was the main cause of the interest rate cut, stands at 3.8% in 2013 – following a 3.3% growth rate in 2012. However, the bank notes that 1% of the forecast is ascribed to gas discoveries and depends on whether the production of natural gas from the Tamar field
begins in the first half of 2013.
Excluding the production of natural gas from the Tamar field, GDP is expected to increase in 2013 by 2.8%, down 0.2% compared to the previous forecast, which points to continued slowdown.
The central bank's research department notes that since the last forecast, in September, central banks in major economies have revised their growth forecasts downwards.
The lower forecasts imply that the demand for Israeli products will continue to drop and that further slowdown is expected in exports abroad.
In addition, the Bank of Israel sees a negative effect on incoming tourism as a result of the security-related situation. Although the direct damage to the Israeli economy caused by Operation Pillar of Defense is estimated at a relatively low rate of NIS 500-700 million (about $133-187 million), the bank is still concerned by the operation's negative effect on potential tourists' feeling of safety in Israel.
The Bank of Israel noted Monday evening that "gas production requires only very small inputs of labor, and accordingly the expected development of employment and unemployment is determined largely by the growth rate of GDP excluding (rather than including) gas production.
Nonetheless, the delay in gas flow is expected to affect two important factors: The lower growth rate may result in a decline in the State's income tax and limit the state budget, which increases every year in accordance with the growth rate.
In addition, electricity prices are expected to rise by 10-15% in March, and the price hike will also be affected by the progress made in drilling in the large gas field.