Merrill Lynch says that the Bank of Israel monetary exit strategy can serve as a lesson to the Federal Reserve Bank and other major central. (Merrill Lynch analyst Turker Hamzaoglu adds that the recommendation to learn from the Bank of Israel is not because Governor of the Bank of Israel Prof. Stanley Fischer was Federal Reserve Board Chairman Ben S. Bernanke's PhD advisor in MIT.)
Merrill Lynch notes that the Bank of Israel is the only emerging market central bank to have raised its interest rate, and it was the first central bank in the world to unwind its quantitative easing. "The Bank of Israel’s experience suggests that the exit strategies can be smoother than expected and market-positive when they come as normalization of monetary policy that confirms a recovering healthy economy."
Hamzaoglu also notes that the Bank of Israel was one of the most proactive central banks, as it cut interest rates steeply and then continued with unconventional measures, such as daily foreign currency and bond purchases. It expanded its balance sheet, which has increased 61% year-to-date and reached NIS 252 billion as of the end of September. The Bank of Israel bought nearly NIS 20 billion in government bonds and boosted its foreign currency reserves to $60 billion from $28 billion in February.
Hamzaoglu says, "The Bank of Israel has built strong credibility over the years for usually being ahead of the curve both in easing and tightening cycles. As a small economy, the Israeli hike has largely seen as a special case."
"The bank is trying strike a balance between supporting the recovery, and considerations of price stability, financial stability and asset bubbles. A sound financial sector, rapid economic recovery, high inflation and higher asset prices led Bank of Israel to start unwinding the stimulus," Hamzaoglu says.
Merrill Lynch notes that Israel is a small and open economy, but managed to escape with only a brief recession of two quarters. The economy grew 0.8% in the second quarter of 2009, after contracting by 1.6% in the fourth quarter of 2008 and 3.3% in first quarter of 2009. The recovery is becoming broad-based and the unemployment rate came down to 7.6% in August, after peaking at 7.9% in May.
Hamzaoglu cites Fischer’s message on exit strategies at the IMF/World Bank Annual Meeting Istanbul in early October as clear and illuminating for policymakers around the globe: “The Bank of Israel introduced an extra-loose monetary policy to fight against recession and deflation. Once the macro data proved that it was not the case and financial system proved to be sound and well functioning, the bank reversed the excessive stimulus first and then started to hike rates."
The analyst predicts that Israel's GDP growth rate will accelerate to 4% by 2011. Since few other central banks are raising their interest rates, the Bank of Israel does not have to make aggressive rate hikes. It adds that the markets are already rewarding the Bank of Israel's policy of unwinding of excessive monetary easing, as inflation drops, inflation expectations improve, and yield curve shifts lower.
Hamzaoglu concludes, "As we expect the global recovery to surprise to the upside in 2010, the withdrawal of excess monetary easing will be a fragile issue to handle. Israel’s experience showed that an earlier-than-expected hike was welcomed by the markets as the recession proved to be largely cyclical rather than fundamentally driven. A gradual unwinding not only anchored inflation expectations and eased concerns regarding fiscal gap, but it also supported the growth outlook, as a downward shifting yield curve helped lower mortgage rates."
Hamzaoglu's comments were issued in a Bank of America Merrill Lynch Global Research Report.
Published by Globes [online], Israel business news - www.globes-online.com - on November 10, 2009
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