The Bank of Israel's Monetary program for February 2001

January 29, 2001


The Bank of Israel today announced its monetary program for February 2001, according to which its interest rate will be reduced by 0.3 percentage points.

The Bank of Israel explains that the decision to lower the nominal interest rate for February by this amount is consistent with the long-term inflation target set by the government. The decision was taken against the background of the current assessment that inflation in 2001 will be between 1 percent and 2.5 percent a year, below the lower limit of the target range for the year, and that in the 2002 and 2003 it will be within the range of the long-term target set by the government. It will be recalled that the government decided that monetary 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 a long-term inflation target path reflects a commitment to maintaining long-term price stability as a major component in Israel’s integration into the global economy. In so doing, it also helps interest-rate policy to bring inflation into the target range and to consolidate and maintain sustainable economic growth. 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 inflation rate, and maintains economic stability.

The Bank of Israel points out that the policy pursued in the last two years, of careful, gradual cuts in the rate of interest leading to the convergence of the domestic interest rate with international rates, contributed to the stability achieved in Israel’s financial markets in the last two years. This is all the more notable an achievement in the light of the increased volatility in world markets, particularly in the US stock exchanges, and the rise in economic uncertainty caused by domestic political developments and changes in the geopolitical situation. This uncertainty has grown recently, partly related to unrest in the public-sector labor market and concern regarding a weakening of fiscal discipline in the current year.

The Bank notes that the period of low inflation in the economy has already contributed to changes in the wage negotiation process, to the willingness to base the financing of the budget deficit on unindexed bonds and lengthen their maturity, and to the awareness of the need to switch from CPI-adjusted financial statements to nominal ones. The Bank of Israel hopes that the infrastructure created so far is sufficient to establish a tax system on a nominal basis in the future. The Bank adds that the risk premium which international capital markets ascribe to Israel’s economy is currently estimated at between one percentage point (for half a year) and 1.9 percentage points (for 10 years), a reduction from last month’s level. The change in interest-rate differentials between Israel and overseas has implications for capital flows and the management of the public’s portfolios of assets and liabilities, and thus for Israel’s financial markets. It is relevant to note that one of the important elements affecting the domestic foreign-currency market and the exchange rate of the NIS is long-term foreign investment in Israel. The supply of foreign exchange from this source has slackened in the last few months, and this, if it continues, could have implications for the exchange rate and the inflation rate.

The Bank of Israel explains that one of the features of price stability is low monthly price volatility. Despite the reduction in inflation in the last two years, however, no parallel reduction in the monthly fluctuations of the CPI is evident yet, and the standard deviation and the range of fluctuations in changes in the CPI are similar to those of the mid-1990s. This is an indication of the fragility of price stability at this stage of the process of bringing inflation under control.

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 changes in any single Consumer Price Index-whether it happens to fall or rise relatively steeply or by a small amount. 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 one to three years.



Table 1. 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
0.5
2.0
February
0.3
Interest level in January 2001 (perecet, annual rate)
January
8.0
6.0
2.0
February**
7.7

*The comparison of interest rates requires reference also to Israel's country risk, which according to international capital markets now ranges from one percentage point (for half a year) to 1.9 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 rate of interest, prior to the review, is 6.0 percent.
Table 2. Range of Monthly Changes in the CPI Relative to Annual Rate of Inflation, 1999-2000
(percent)
   

Range of change of CPI

 
 

 

 

Annual rate of inflation

 

 

Greatest change in CPI

 

 

Smallest change in CPI

Difference between largest and smallest change in CPI

Ratio of the difference to annual rate of inflation

Inter-month standard deviation

 

(1)

(2)

(3)

(4)=(2)-(3)

(5)=(4)/(1)

(6)

1990

17.6

2.5

0.4

2.1

0.12

0.62

1991

18.0

3.0

0.1

2.9

0.16

0.88

1992

9.4

1.8

-0.4

2.2

0.23

0.63

1993

11.2

1.4

0.1

1.3

0.12

0.46

1994

14.5

2.0

0.6

1.4

0.10

0.36

1995

8.1

1.2

-0.1

1.3

0.16

0.46

1996

10.6

1.7

0.3

1.4

0.13

0.45

1997

7.0

1.2

-0.3

1.5

0.21

0.55

1998

8.6

3.0

-0.2

3.2

0.37

0.93

1999

1.3

0.7

-0.8

1.4

1.08

0.44

2000

0.0

0.9

-0.6

1.5

 

0.48


* Monthly fluctuations in the CPI vis-a-vis the average monthly change in the index in that year.