27.12.04
 
The Bank of Israels Monetary Program for January 2005
 
The Bank of Israel today announced that in the context of its monetary program for January 2005, the interest rate will be reduced by 0.2 of a percentage point, to 3.7 percent. The decision to lower the interest rate is based on the Banks assessment that the expected rate of inflation next year is within the range of the government's target of price stability, i.e., 1-3 percent a year.
Developments in the foreign currency market, the Treasury bill market, and the government bond market also help to make it possible to continue preserving price stability at a lower interest rate:
The foreign currency market is stable. The exchange rate continues to be relatively stable. Since the beginning of the year the NIS appreciated by about one percent against the dollar, and depreciated by about one percent against the currency basket. Bid-offer spreads remain low, and Israel's general country risk premium and the risk premium of the foreign currency market also continue to be low.  
The Treasury bill market is calm, and has shown a persistent reduction in yields in the last few months. Thus, the yield on one-year Treasury bills which reached its 2004 peak in May, at 5.2 percent, is currently down to only 4.3 percent.  
In the government bond market, for both CPI-indexed and unindexed bonds, the decline in yields to all terms persists. For example, the yield on unindexed 10-year government (Shahar) bonds went down from 7.9 percent in May to 7.3 percent in December, and in the same period the real yield on indexed 10-year government (Galil) bonds declined from 4.4 percent to 4.1 percent. This decline is an indication of the public's confidence that the government will continue to observe fiscal discipline. In this context the great importance of the Knesset's approval of the 2005 budget along the lines confirmed by the government must be stressed yet again.  
Despite the above, the uncertainty deriving from the markets' potential reaction to the large deficits in the US budget and current account-that is likely to affect the future level of the interest rate and growth in the US, and hence also, directly and indirectly, Israel's economy-cannot be ignored. Nevertheless, Israel's economy is continuing along a path of growth, and additional jobs are being created, and there are signs of a slow downward trend in unemployment, with a rise in the rate of participation in the labor force. Investments still constitute the Achilles' heel of the growth process. In this context it would be appropriate to afford special attention to providing renewed impetus to infrastructure investment.
In the last two years the Bank of Israel has changed the focus of its interest-rate policy so as to support economic growth. Within this framework the Bank reduced the interest rate from 9.1 percent in December 2002 to the current rate of 3.7 percent. Concurrently, real interest came down from about 7 percent to its present level of 2-3 percent. This process also had a significant effect on the money supply: in the first half of 2003 the change in the money supply, with the high interest rate, was negative; as the interest rate was reduced, the money supply started expanding from the second half of 2003, and in 2004 the rate of change increased till it reached 20 percent a year in the second half of the year. Against the background of fiscal discipline observed in the last two years, the process of lowering the short-term interest rate by the Bank of Israel contributed to the reduction of medium-term and long-term yields, as well as to the rise in the stock market. These developments help to lower the cost of sources of finance, and thereby have positive implications for the recovery of real economic activity.
The Bank of Israel will continue to monitor closely: the effects on capital flows of the contraction of the differential between its interest rate and that of the US Federal Reserve and the contraction of the yield gaps between US and Israeli government bonds; the trends of capital flows to and from emerging markets; and changes in the risks attributed to Israel's economy by Israeli and foreign investors. These risks are still at a low level, enabling the continued contraction of the differentials between Israel's interest rate and those abroad, without disturbing the equilibrium of the foreign currency market.
 
Table 1: Interest Rates in Israel and the US
Yield spread between US and Israel 10-year govt. bondsc Central banks interest rates  
Differential between central banks interest ratesb US Israel  
Interest rate Change Interest ratea Change End of year
8.75 4.75   13.50   1998
3.05 5.70 5.50 0.75 11.20 2.3 1999
4.0 1.70 6.50 1.00 8.20 3.0 2000
1.6 4.05 1.75 4.75 5.80 2.4 2001
6.8 7.85 1.25 0.50 9.10 3.30 2002
3.0 4.20 1.00 0.25 5.20 3.9 2003
            Monthly data
6.8 7.85 1.25 0.00 9.10 0.00 2002 December
7.5 7.65 1.25 0.00 8.90 0.2 2003 January
7.9 7.65 1.25 0.00 8.90 0.00 February
7.0 7.65 1.25 0.00 8.90 0.00 March
5.6 7.45 1.25 0.00 8.70 0.2 April
5.0 7.15 1.25 0.00 8.40 0.3 May
4.7 6.75 1.25 0.00 8.00 0.4 June
4.1 6.50 1.00 0.25 7.50 0.4 July
4.3 6.00 1.00 0.00 7.00 0.5 August
4.0 5.50 1.00 0.00 6.50 0.5 September
3.6 5.10 1.00 0.00 6.10 0.4 October
3.3 4.60 1.00 0.00 5.60 0.5 November
3.0 4.20 1.00 0.00 5.20 0.4 December
3.1 3.80 1.00 0.00 4.80 0.4 2004 January
3.5 3.50 1.00 0.00 4.50 0.3 February
3.8 3.30 1.00 0.00 4.30 0.2 March
3.6 3.10 1.00 0.00 4.10 0.2 April
3.2 3.10 1.00 0.00 4.10 0.00 May
3.0 3.10 1.00 0.00 4.10 0.00 June
3.2 2.85 1.25 0.25 4.10 0.00 July
3.7 2.60 1.50 0.25 4.10 0.00 August
3.8 2.35 1.75 0.25 4.10 0.00 September
3.4 2.35 1.75 0.00 4.10 0.00 October
3.2 2.10 2.00 0.25 4.10 0.00 November
2.7 1.65 2.25d 0.25 3.9 -0.20 December
  1.45 2.25e   3.7 -0.20 January 2005
 
a The rate of interest set in the previous months monetary program for the month indicated in the table.
b The risk premium, as measured by the 5-year credit-default-swap (CDS) market was
  about 41 basis points inDecember.
c The yield spread between 10-year Shahar bonds and 10-year US government bonds.
d The rate of interest in the US was changed on 14 December 2004.
e The Open Market Committee of the US Federal Reserve is due to convene on February 2nd 2005 for
  its regular review of interest-rate policy.
 
Table 2: The Bank of Israel Real Rate of Interest, the Nominal Yield on Treasury Bills and on Unindexed Government Bonds, and the Real Yield on CPI-Indexed Government Bonds
(monthly average, percent)
Yield on unindexed 10- year bondsd Real yield on CPI- indexed 10- year bonds Yield on 12 month Treasury bills Bank of Israel rate of Interest  
Realc Effectiveb Headline rate (simple)a
10.9 5.7 7.9 7.2 9.6 9.1 2002 December
11.4 5.9 8.1 6.5 9.4 8.9 2003 January
11.7 5.8 8.7 5.4 9.4 8.9 February
10.7 5.6 8.6 6.1 9.4 8.9 March
9.5 5.4 8.2 7.2 9.2 8.7 April
8.5 5.0 7.6 7.4 8.8 8.4 May
8.0 4.6 7.1 6.8 8.4 8.0 June
8.0 4.4 6.7 5.4 7.9 7.5 July
8.6 4.7 6.6 5.4 7.4 7.0 August
8.3 4.6 6.2 5.2 6.7 6.5 September
7.6 4.4 5.8 4.7 6.4 6.1 October
7.3 4.2 5.4 4.7 5.8 5.6 November
7.0 4.1 4.9 4.6 5.4 5.2 December
7.0 4.0 4.7 3.8 5.0 4.8 2004 January
7.4 4.1 4.9 3.2 4.7 4.5 February
7.4 4.2 4.9 3.3 4.5 4.3 March
7.6 4.3 4.8 2.7 4.3 4.1 April
7.9 4.4 5.2 2.3 4.3 4.1 May
7.8 4.3 5.0 2.5 4.3 4.1 June
7.8 4.3 4.8 2.8 4.3 4.1 July
7.9 4.3 4.8 2.4 4.3 4.1 August
7.7 4.2 4.7 2.3 4.3 4.1 September
7.6 4.2 4.8 2.2 4.3 4.1 October
7.4 4.2 4.7 2.3 4.3 4.1 November
7.3 4.1 4.3 3.0 4.1 3.9 December
          3.7 January 2005
 
a Announced interest rate in simple annual terms (excluding compound interest).
b Calculated as the daily compound interest rate, based on the interbank rate (see explanation in BOI
  no. 2, p. 17).
c The real rate of interest is the effective rate of interest less inflation expectations derived from the
  capital market.
 
Table 3: Central-Bank Interest Rates in Several Countries, December 2004
Israel's interest rate relates to December
Advanced countries Interest rate (percent)
Japan 0.00
Switzerland 0.75
US 2.00
ECB 2.00
Denmark 2.15
Norway 1.75
Canada 2.50
Sweden 2.00
UK 4.75
New Zealand 6.25
Australia 5.25
Emerging markets  
Thailand 2.00
Taiwan 1.625
Chile 2.25
Korea 3.25
Israel 3.70
Mexico 8.20
South Africa 7.50
Brazil 17.75
Turkey 18.00
Other developing countries  
Czech Republic 2.50
Poland 6.50
Hungary 9.50