The Bank of Israel's Monetary program for April 2001


Monetary program for April 2001

26 MArch 2001


The Bank of Israel today announced its monetary program for April 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 April 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 the period to which the target relates will be between 1.5 percent and 2.5 percent a year-slightly below the lower limit of the target range for 2001, and within the range set by the government in the longer term. Thus, the reduction of the interest rate contributes to attaining the inflation target in 2001 and is consistent with achieving it in the coming years. It will be recalled that the government decided that interest-rate policy should aim at attaining an inflation target of 2.5 to 3.5 percent in 2001, 2 to 3 percent in 2002, and 1 to 3 percent-a range which is defined as price stability-in 2003 and subsequently. Monetary policy aspires to achieve these targets, which help Israel to integrate successfully into the global economy and serve to buttress sustainable economic growth. At the same time it minimizes fluctuations in the rate of interest, thereby lowering volatility in the money, capital, and foreign-currency markets.

The Bank of Israel points out that the decision to reduce the interest rate this month was made inter alia in the context of uncertainty regarding the government's budgetary policy for this year, and its implications for the announced path of continued deficit reduction in the next two years.

As regards the national budget, there are apprehensions that acceding to demands to increase various budgetary items, general government sector wage agreements, and private legislation, without making equivalent cuts in other expenditure items, could significantly increase the budget deficit for 2001, especially in view of a possible drop in tax receipts due to the economic slowdown. A major divergence in government expenditure and the budget deficit this year will impede attainment of the declining path of the deficit, and raises questions concerning the government's commitment to the steady reduction of the deficit and the debt, which has been a cornerstone of macroeconomic policy in the last decade. Furthermore, the increase in the deficit could be accompanied by a rise in government expenditure as a share of GDP, as well as by a change in the composition of this expenditure in a direction that does not support growth but serves to raise the standard of living without being based on sustainable sources.

The Bank of Israel also notes that in the wake of the sharp falls in share prices in the US stock markets, long-term investments in Israel by nonresidents is expected to decline this year, continuing the reduction in the supply of foreign currency from this source in recent months. The contraction of capital inflow has implications for both the exchange rate and the inflation rate, although in view of the moderation of economic activity and slowing of demand, the effect of the exchange rate on the inflation rate appears to be less than in the past. The risk premium which international capital markets ascribe to Israel's economy is currently estimated at between 1.1 (for half a year) and 1.9 percentage points (for 10 years), a slight rise from last month's level. The interest-rate differential between Israel and overseas widened a little in March because US interest rates declined more steeply than those in Israel, but this came after the ongoing contraction of the differential since the end of 1998-from 9 percent to only 2 percent in the last few months. Note that the interest-rate differential has repercussions on both capital flows and the composition of the asset and liabilities portfolio, and through them on Israel's financial markets.

The Bank of Israel notes also that the assessment of the inflation path for one and more years ahead, against the backdrop of the long-term horizon of the inflation target, is based 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, neither are short-term fluctuations in the exchange rate or in inflation expectations of any significance unless they incorporate elements that may alter the assessments of inflation within the policy horizon-the following one to three years.


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
-0.5
2.2
March
-0.2
-0.5
2.5
April
-0.3
Interest level in January 2001 (perecet, annual rate)
January
8.0
6.0
2.0
February
7.7
5.5
2.2
March
7.5
5.0
2.5
**April
7.2


*The comparison of interest rates requires reference also to Israel's country risk, which according to international capital markets now ranges from 1.1 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 May 15 for its regular review of interest-rate policy. The current Federal Reserve rate of interest, prior to the review, is 5.0 percent.