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Israel’s central bank has warned that its policy of keeping its foreign exchange reserves at record lows may be a recipe for a sharp slowdown in the Israeli economy.
On Thursday, the central bank announced that it had cut its overnight interest rate by half in the wake of a sharp decline in the value of the Israeli currency.
Netanyahu, who has been on the defensive since a string of attacks by Palestinian militants killed three Israelis and wounded more than 100 others in the occupied West Bank and East Jerusalem, has vowed to cut the government’s foreign exchange surplus by more than 40 percent in the next three months to prevent a return to the financial crisis that gripped the country in the late 1990s.
The central bank, which has kept interest rates at record low levels, said that it would now raise the rates by half, to 0.5 percent from 0.25 percent.
The move was the latest sign that the government was struggling to contain the damage from the war that ended more than two years ago and the subsequent economic downturn that followed.
But the central Bank’s decision to lower its overnight rate has also triggered a sharp drop in foreign exchange demand, which is also causing the bank to cut interest rates.
The drop in demand has led the central banks of some European countries, including Germany, France and the Netherlands, to cut their overnight interest rates, but this week the Bank of England, the UK’s central bankers’ main monetary authority, also lowered its rates, to the point where it is no longer in line with the central government’s policy.
In its latest statement on Thursday, Israel’s Central Bank said that the foreign exchange market was “now at its record low” and that it is necessary to lower interest rates “to prevent a sharp fall in the foreign currency reserves” of the country.
“The government has no choice but to lower the interest rate, in order to prevent the decline in foreign currency demand that is now at its highest level in more than a decade,” the central board said.
“This is a major measure to avoid the further deterioration of the domestic economy.”
Israel’s economy contracted by 6.3 percent in 2016, the worst slowdown in more in more years, and the central bankers had warned of the dangers of a steep drop in growth.
On Wednesday, the Israeli government warned of an “extreme” rise in inflation and warned of “serious risks” to the country’s financial system.
The economy contracted in the second quarter of 2016 by 0.9 percent, the lowest since January 2008.
Inflation reached 5.7 percent in June, a new record, the biggest monthly increase in five years, as households and businesses faced a tough financial squeeze.
In the run-up to the vote, Israel also cut foreign aid, the largest cut in the European Union’s arms embargo and the largest in its history.
The Israeli government has also raised the number of foreign workers it requires for the construction sector from about 4,000 to 5,000, to cope with the sharp drop-off in foreign investment in the country as well as in the rest of the European bloc.