The Bank of Israel's Monetary program for January 2001

December 25, 2000


The Bank of Israel today announced its monetary program for January 2001, 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 January 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 three years will be between 2.0 percent and 3.0 percent a year, slightly below 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 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 integration into the global economy. Setting a long-term target also helps interest-rate policy achieve its objective of bringing inflation into the range defined as price stability and maintaining it at that level in the long run, while providing a firm basis for current growth and ensuring its long-term 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 thus maintains economic stability.

The Bank of Israel points out that interest-rate policy must adhere to its long-term objectives, and it is not intended, nor indeed able, to offset short-term fluctuations in the economy’s current activity, signs of which have been evident in the last few months. Furthermore, the relative stability which is a feature of Israel’s financial markets, particularly in the light of the increased volatility of the US capital markets, has been accompanied by greater economic uncertainty deriving from the domestic situation and possible geopolitical changes. On the one hand, the stability shown by the markets allows the cautious and gradual process of lowering the rate of interest to continue, but on the other, increased uncertainty against the background of the reduced interest-rate differential between the US and Israel-which has contracted from about 9 percentage points two years ago to 1.5 percentage points today-calls for great caution to be exercised in the pace at which the interest rate is cut and in the frequency of future changes.

The Bank again notes that the risk premium which international capital markets ascribe to Israel’s economy is currently estimated at between 1.2 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, has implications for capital flows and the composition 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.

In this context it is relevant to note that there has been significant capital inflow into Israel in the last few years, particularly into high-tech industries, based mainly on the rise in prices of high-tech stock in the US capital market. Falling prices in recent months and greater uncertainty associated with the security-related incidents give rise to the current assessment that capital imports by nonresidents in 2001 are likely to be below their level in 2000, when foreign investments in Israel reached an unprecedented peak. It is also estimated that the current-account deficit in 2001 is likely to exceed that in 2000.

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-which is between one and three years forward.

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 (precentage annual rates)
December 1998
13.50
4.75
8.75
December 1999
11.20
5.50
5.7
December 2000
8.2
**6.5
1.7
Changes in interest rate 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
Changes in interest rate in 2000 (percentage points)
January
-0.5
0
5.20
February
-0.4
0.25
4.55
March
-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
0
1.7
Changes in interest rate in 2001 (percentage points)
January
-0.2
Interest level in January 2001 (perecet, annual rate)
January
8.0
6.5
1.5


* The comparison of interest rates requires reference also to Israel’s country risk, which according to international capital markets now ranges from 1.2 percentage points (for half a year) to 2.1 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 January 31 for its regular review of interest-rate policy. The current Federal Reserve interest rate, prior to the review, is 6.5 percent.