Monetary Policy Report 2016 - Second Half

23/02/2017
All Publications In Subject:
Monetary Policy and Inflation
Summary of recent economic developments
 
Monetary policy: In the second half of 2016, the Monetary Committee left the benchmark rate unchanged at 0.1 percent, and continued to assess that monetary policy would remain accommodative for a considerable time. During the reviewed period, however, the Committee expressed the view that it is no longer needed to examine the use of various monetary tools. Within the framework of monetary policy, the Bank of Israel continued to purchase foreign currency, buying $2.6 billion during the reviewed period. The Committee preferred to make use of foreign exchange market intervention, rather than a further reduction in the interest rate, because of the risks inherent in a negative interest rate policy. In September, the Committee decided to reduce the frequency of interest rate decisions from twelve to eight per year, from 2017 onward.
Inflation and inflation expectations: In the twelve months ending in December 2016, the Consumer Price Index declined by 0.2 percent. During the review period, the annual inflation rate increased, as the direct effect of declines in energy prices and of government-initiated price reductions dissipated. One-year inflation expectations and one year, one-year forward expectations (that is, second year forward expectations) continued to range below the lower bound of the inflation target. Forward expectations for medium terms were above the lower bound, and forward expectations for longer terms (5–10 years) remained anchored at around the midpoint of the target range.
Domestic real activity: Revised National Accounts data for the second and third quarters indicated that the economy is growing by a more rapid rate than had been previously published, driven by private consumption and fixed capital formation—components that continued to be supported by low interest rates. Throughout the second half, growth data were adjusted upward markedly, and the first estimate of full-year year data from the Central Bureau of Statistics showed 3.8 percent growth in 2016. In discussions on the interest rate for September, the committee members expressed the view that given the large increase in the first-quarter growth estimate, the risks to growth had diminished. The labor market continued to display resilience and the unemployment rate remained low; these developments were reflected in wage increases and in the number of job vacancies.
Exchange rate: During the review period, the shekel appreciated in nominal effective exchange-rate terms, primarily due to depreciation against the euro against the background of the eurozone’s continued monetary accommodation and low growth environment. Conversely, the dollar maintained its value against the shekel and appreciated against most currencies worldwide. For the period overall, the shekel appreciated by 5.2 percent against the currency basket (June average vs. December average). The appreciation continued to weigh on the continued growth of goods exports. Various equilibrium exchange-rate models that were presented to the Monetary Committee indicate that the shekel is overvalued. The Monetary Committee assesses that a significant share of the appreciation is based on enhanced monetary accommodation worldwide, particularly negative interest rates and quantitative easing programs in Europe and Japan. This accommodation forced several countries (such as Sweden and Switzerland) to adopt similar policy, and in other countries central banks had to reduce the interest rate and intervene in the foreign exchange market to prevent further currency appreciation that would negatively impact exports. The main objective of the intervention policy is to moderate the effect on the economy of the atypical monetary accommodation of Israel’s trading partners, without necessitating the extreme means adopted by Europe and Japan.
Global economy: The growth rate of global economic activity remained moderate during the second half of 2016; concurrently, the forecasts of leading international entities, for both global growth and world trade, were revised downward. These entities also assessed that the risks to the forecasts tended to the downside. The revision of these forecasts was influenced by unforeseen developments in the global economy: the results of Britain’s referendum in favor of Brexit and the increase in political uncertainty. Oil prices held steady during most of the period after rising sharply in the previous half-year, and they moved up again toward year’s end. In parallel, bond yields increased sharply in major bond markets and inflation expectations increased in the medium to long terms. Monetary policy remained markedly accommodative in most major markets, and became even more accommodative in most of them. Conversely, the US Federal Reserve decided in December to raise its benchmark rate to 0.5–0.75 percent. According to the median estimate among members of the FOMC, the pace of rate-hiking will be slightly faster than previously assessed.
Housing market: Home prices continued to rise in the second half of 2016. New mortgage volume declined from the record reached at the beginning of the year but the number of transactions remained high. Mortgage interest rates continued to increase and the spread over government-bond interest rates continued to widen in view of the upturn in risk in the banking system’s housing-credit portfolio, an increase in the cost of the sources that the banks raise, and previous measures by the Banking Supervision Department to mitigate risk to borrowers and banks. The stock of homes available for sale continued to grow in the half-year reviewed, reaching a record level. The annual rate of increase in housing rent declined slightly toward the end of the review period.
Financial markets: Domestic equity indices remained essentially unchanged during the review period (in dollar terms, December average vs. June average), similar to the leading indices in Europe and in emerging markets and in contrast to US indices, e.g., the S&P 500, which continued its rally seen in the preceding half year. Domestic nominal and real yield curves increased for medium and long terms, as did curves abroad—consistent with the stability that medium- and long-term inflation expectations have been displaying. The spreads between corporate bonds and similar government bonds remained stable in the second half of 2016.
Fiscal developments: The cumulative domestic deficit (excluding net provision of credit) was NIS 20.7 billion in July–December 2016, compared with NIS 18.8 billion in the corresponding period a year earlier (constant prices). The annual deficit was 2.1 percent of GDP, markedly lower than the target (2.9 percent) and similar to the 2015 deficit. The deviation from the original budget forecast reflects higher revenues—from taxes and from surpluses on National Insurance Institute activity—as total expenditures largely adhered to the original budget. Total tax revenues in 2016, net of legislative changes and timing differentials in respect of vehicle imports, increased by 5.5 percent relative to the previous year, similar to the growth rate of nominal GDP. The share of public debt in GDP declined to 61.9 percent.

Research Department forecasts: In the forecasts that it formulated toward the end of December 2016 (before the Central Bureau of Statistics released its full year estimate), the Research Department estimated GDP growth in 2016 at 3.5 percent (as against 2.8 percent in the previous forecast), and projected growth of 3.2 percent in 2017 and 3.1 percent in 2018. According to the forecast, inflation is expected to converge gradually to within the target range in the next few quarters, reaching 1 percent of the end of 2017 and 1.5 percent in 2018. The Bank of Israel benchmark rate, according to the forecast, is expected to stay at its current level until the third quarter of 2017 and to increase to 0.5 percent at the end of 2018.

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