The Bank of Israel's Monetary program for December 2000


November 27, 2000


The Bank of Israel today announced its monetary program for December 2000, according to which its interest rate will be reduced by 0.2 percentage points.

The Bank of Israel explains that the decision to lower the nominal interest rate for December by this amount is consistent with the long-term inflation target set by the government. The decision was taken against the background of the assessment that inflation in the next few years will be between 2 percent and 3 percent a year, close to the lower limit of the target range for 2001, and in the area of the price-stability target set by the government for the medium term. It 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 a major component in Israel’s ability to integrate 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, which helps lower volatility in the money, capital and foreign-currency markets and in the rate of inflation, and maintains economic stability.

The Bank of Israel points out that the price-stabilization process is still exposed to risks deriving inter alia from increased uncertainty in three main areas: firstly, the downward price trend and volatility in the US capital markets, which has intensified recently, raises questions regarding the long-term characteristic of capital inflow to Israel. As is well known, developments in the high-tech industries, which were reflected in rising stock prices in the US capital market in the last few years, encouraged foreign investment in Israeli companies engaged in that field, and this constituted an important source of capital inflow. Second, there has been concern recently regarding the government’s ability to maintain fiscal control, concern which stems from difficulties encountered in obtaining approval of the budget for 2001 and in the approval of private bills which increase government expenditure irrespective of the budget framework. In this context, it is relevant to note that till now these threats have not been realized in the performance of the budget. Third, the continuation of the recent security-related incidents, which have so far had only a slight affect on the domestic financial markets compared with what might have been expected based on similar events in the past, presents a new test of the economy’s ability to go on integrating into the global economy. These uncertainty factors, however, have not as yet affected the various assessments of the expected inflation path for the next few years.

The Bank again stresses that the risk premium which international capital markets ascribe to Israel’s economy is currently estimated at between 1.3 percentage points (for half a year) and 2.1 percentage points (for 10 years), a slight reduction from last month’s level. The continued reduction in interest-rate differentials between Israel and overseas, taking the risk premium into account, 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, 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. It must be borne in mind that 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.

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
0
2.40
October
-0.3
0
2.10
November
-0.2
0
1.9
December
-0.2
1.7
Interest level in October 2000 (percent, annual rate)
8.2
6.5**
1.7

* The comparison of interest rates requires reference also to Israel’s country risk, which according to international capital markets now ranges from 1.3 percentage points (for half a year) to 2.1percentage 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 December 19 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
1.15
1.5
-0.8
0.7
1.3
1999
1.5
-0.6
0.9
2000*

* January to October