Monetary program for November 2000

October 23, 2000

The Bank of Israel today announced its monetary program for November 2000


* according to which its interest rate will be reduced by 0.2 percentage
points. The Bank of Israel explains that underlying the decision to lower the nominal interest rate for November by this amount was the assessment that inflation in the next few years is in line with the long-term inflation target set by the government, and the decision thus also supports the attainment of the government’s other targets without endangering the achievement of the inflation target. It will be recalled that the government decided that interest policy should focus on attaining the inflation target of 2.5 to 3.5 percent for 2001, 2 to 3 percent for 2002, and 1 to 3 percent-a range which is defined as price stability-from 2003 onwards. Setting an inflation target with such a time scale reflects a commitment to maintaining long-term price stability, as part of the strategy of integrating into the global economy. In so doing, it also helps interest-rate policy achieve its objective of bringing inflation into the range defined as price stability and maintaining it at that level, while providing a firm basis for current growth and ensuring its continuity. At the same time it minimizes fluctuations in the rate of interest and maintains economic stability.

The Bank draws attention to another aspect connected with the assessment of stability of the inflation environment, and that is the wide monthly volatility of prices of goods and services, which despite the recent decline in inflation has not changed significantly in the last few years. Thus, for example, the difference between the greatest and the smallest monthly change in the CPI in any given year has remained between 1.3 percentage points and 1.5 percentage points since 1993 (except for 1980) (Table 2). Such high volatility brings with it risks of possible fluctuations in inflation, especially when the annual inflation rate is expected to be relatively low. In this context the Bank of Israel explains that price stability is not only long-term low inflation but also low volatility of monthly changes in the CPI.

The Bank again stresses the importance of keeping a close watch on the risk premium which international capital markets ascribe to Israel’s economy-this has risen recently and is currently estimated at between 1.4 percentage points (for half a year) and 2.2 percentage points (for 10 years). The rise in the risk premium, particularly in the light of the continued reduction in interest-rate differentials between Israel and overseas, can have implications for capital flows and the management of the public’s assets and liabilities portfolios, and thus for Israel’s financial markets. The Bank of Israel again points out in this context that the dollar interest rate is the main substitute for the local-currency interest rate because of the present currency composition of the public’s foreign-currency assets and liabilities and of capital flows to and from Israel.

The Bank of Israel notes again that the assessment of the inflation path for one and more years ahead-currently between 2 and 2.5 percent a year, approximately-against the background of the long-term horizon of the inflation target, is based as always on the Bank’s forecasts of inflation, on inflation expectations derived from the capital market, and on the predictions of various private forecasters. In this context, it is estimates of inflation for the next 12 months and beyond that are significant, and not any single Consumer Price Index-whether it happens to fall or rise relatively steeply or by a small amount-nor estimates for any period shorter than one year. Similarly, short-term fluctuations in the exchange rate or in inflation expectations also hold no significance, unless they incorporate elements that may alter the assessments of inflation within the policy horizon-the following 12 months and beyond. The Bank adds that changes in the money supply over time, which are currently consistent with progress towards achieving the inflation target, the development of real economic activity, and fiscal developments, all form part of the basis for assessing current and future interest-rate policy which is aimed at achieving the required convergence towards price stability


Changes in the Interest Rates of the Central Banks of Israel and the US
ISRAEL
US
Differential between NIS and dollar interest rates* (percentage points)
Interest level in December 1998
13.50
4.75
8.75
Changes in interest in 1999 (percentage points)
January
0
0
8.75
February
0
0
8.75
March
-0.5
0
8.25
April
-0.5
0
7.75
May
-0.5
0
7.25
June
0
0.25
7.00
July
0
0
7.00
August
-0.5
0.25
6.25
September
0
0
6.25
October
0
0
6.25
November
0
0.25
6.00
December
-0.3
0
5.70
Interest level in December 1999 (percent, annual rate)
11.2
5.50
5.70
Changes in interest rate in 2000 (percentage points)
January
-0.5
0
5.20
February
-0.4
0.25
4.55
Marce
-0.4
0.25
3.90
April
-0.3
0
3.60
May
-0.3
0.5
2.80
June
0
0
2.80
July
0
0
2.80
August
-0.2
0
2.60
September
-0.2
2.40
October
-0.3
2.10
November
-0.2
1.9
Interest level in October 2000 (percent, annual rate)
8.4
6.5**
1.9

* The comparison of interest rates requires reference also to Israel’s country risk, which according to international capital markets now ranges from 1.4 percentage points (for half a year) to 2.2 percentage points (for 10 years). Note that the risk premium is characterized by volatility which is sometimes caused by factors related to Israel’s economy, and sometimes by global events.
** The Open Market Committee of the US Federal Reserve is set to convene on November 15 for its regular review of interest-rate policy. The current Federal Reserve interest rate, prior to the review, is 6.5 percent.
Table 2. Range of Monthly Changes in the CPI Relative to Annual Rate of Inflation, 1999-2000
(percent)
Range of change of CPI
Ratio of the difference to annual rate of inflation
Difference between largest and smallest change in CPI

Smallest change in CPI

Greatest change in CPI

Annual rate of inflation
(5)=(4)/(1)
(4)=(2)-(3)
(3)
(2)
(1)
0.12
2.1
0.4
2.5
17.6
1990
0.16
2.9
0.1
3.0
18.0
1991
0.23
2.2
-0.4
1.8
9.4
1992
0.12
1.3
0.1
1.4
11.2
1993
0.10
1.4
0.6
2.0
14.5
1994
0.16
1.3
-0.1
1.2
8.1
1995
0.13
1.4
0.3
1.7
10.6
1996
0.21
1.5
-0.3
1.2
7.0
1997
0.37
3.2
-0.2
3.0
8.6
1998
1.08
1.4
-0.8
0.7
1.3
1999
1.5
-0.6
0.9
2000*

* January to September