The Bank of Israel's Monetary program for July 2001

25 June 2001
Monetary program for July 2001
The Bank of Israel today announced its monetary program for July 2001, according to which its interest rate will be reduced by 0.3 percentage points, to 6.5 percent The Bank of Israel explains that estimates of inflation for the next few years obtained from inflation expectations in the capital market, private forecasters’ assessments, and inflation estimates based on macroeconomic models developed in the Bank of Israel are below the target range for 2001, and within the target range for periods of more than one year, so that the reduction is consistent with the achievement of the target for 2001 and the next few years. As is known, the Bank of Israel’s monetary policy strives to achieve the inflation targets, with the intention of continuing to strengthen the financial stability which the economy has demonstrated in the money, capital and foreign currency markets. This stability has been achieved as a result of monetary policy, among other things. Maintaining and cultivating stability is of special importance in the conditions of uncertainty caused by domestic and external forces to which Israel’s economy is exposed. The Bank of Israel goes on to emphasize that changes in the rate of interest determined according to the inflation target, and the exchange-rate regime do not provide the means for offsetting the dampening effects on Israel’s economy of factors such as the security situation in Israel and the slowdown in the US. The persistence of these developments and the slowdown in economic activity in Israel have widened the output gap, which can itself help slow down the rate of price rises, but as stated above, cutting the rate of interest cannot offset these effects. The Bank of Israel emphasizes that that there is great uncertainty regarding the government’s fiscal policy for 2001, and greater transparency is required, including the submission of a report to the government and the public on the estimated deficit for 2001, using the internationally accepted definitions. As far as budget policy for the next few years is concerned, it is vital to maintain the downward path of the budget deficit in accordance with the government decision of August 2000. Total government expenditure must be contained within the preset limits, giving weight to components which encourage growth, and structural reforms, the pace of which has slowed greatly in the recent past, must be renewed. The Bank of Israel notes that since the beginning of 2000 the rate of interest has been reduced by more than 4 percentage points(from 10.7 percent to 6.5 percent), and real interest, i.e. the Bank of Israel interest rate minus inflation expectations derived from the capital market, has also come down, by more than 2.5 percentage points, and is currently below 6 percent. At the same time real long-term interest, as measured by the yield on government bonds and mortgage interest, has also come down, as has the difference between short-term and long-term real interest. The continuation of the downward trend of real interest depends on the maintenance of an environment of price stability, and this can be achieved only if fiscal discipline is maintained, and the obligation to stick to the reducing deficit targets and to lower government debt is honored. The Bank adds that the risk premium which international capital markets ascribe to Israel’s economy is currently estimated at 0.7 of a percentage point (for half a year) and 1.6 percentage points (for 10 years), a reduction from last month’s level. The interest-rate differential between Israel and overseas is currently about 2.5 percentage points, and it has risen slightly in the first half of 2001 from its level in the first half of 2000. Note that the differential has fallen from a level of about 9 percentage points at the end of 1998 to the 2-3 percent range, while it has had little effect on capital flows as reflected in the share of credit and assets in these aggregates. The Bank of Israel adds that the exchange-rate band should be abolished. It was created in circumstances which no longer apply, and its existence is inconsistent with an inflation-target regime. The crawling exchange-rate band contains the potential for causing a financial crisis, the extent of which cannot be predicted and which could lead to unnecessary and distorting Bank of Israel intervention in the markets.
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
8.8
December 1999
11.20
5.50
5.7
December 2000
8.2
6.5
1.7
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
-0.5
2.7
May
0.0
-0.5
3.2
June
-0.2
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
4.5
2.7
May
7.2
4.0
3.2
June**
6.8
4.0**
2.8
July
6.5
* The comparison of interest rates requires reference also to Israel’s country risk, which according to international capital markets now ranges from 0.7 percentage point (for half a year) to 1.6 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 June 27 for its regular review of interest-rate policy. The current Federal Reserve rate of interest, prior to the review, is 4.0 percent.
The Bank of Israel Real Rate of Interest and the Real Yield on CPI-Indexed Government Bonds (monthly average, percent)
 

Rate of interest in Bank of Israel auctions

 
 

Headline rate (simple) a

Effectivea

Realb

Real yield to redemption on CPI-indexed 10-year bonds

2000     January

10.7

11.4

8.6

5.2

February

10.3

10.9

7.8

5.2

March

9.9

10.5

7.8

5.1

April

9.6

10.1

7.0

5.1

May

9.3

9.9

6.0

5.1

June

9.3

9.9

6.1

5.2

July

9.3

9.8

7.1

5.4

August

9.1

9.6

7.3

5.6

September

8.9

9.4

6.9

5.7

October

8.6

9.1

6.9

5.6

November

8.4

8.9

7.0

5.6

December

8.2

8.6

7.8

5.8

2001     January

8.0

8.4

7.0

5.6

February

7.7

8.1

6.0

5.3

March

7.5

7.9

5.8

5.1

April

7.2

7.6

6.2

5.0

May

7.2

7.6

6.3

4.7

June

6.8

7.4

5.8

 

July

6.5

     
a Calculated in annual terms. b Real rate of interest is the effective rate of interest minus inflation expectations derived from the capital market.