The Bank of Israel's monetary program for August 2001


23 July 2001
The 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 0.2 percentage points, to 6.3 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 within the target range of inflation for 2002, and within the long-term target range. The interest-rate reduction is consistent with the achievement of the target for the next few years and also supports the attainment of the target for 2001. As is known, the Bank of Israel’s monetary policy strives to achieve the inflation targets, the infrastructure essential for sustainable growth and 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 cannot 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 economy. 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. The Bank of Israel emphasizes 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 budget deficit for 2001, using the internationally accepted definitions. Total government expenditure must be contained within the preset limits, with preference given to components which encourage growth, and structural reforms, the pace of which has slowed greatly in the recent past, must be renewed. The downward path of the budget deficit for the next few years, in accordance with the government decision of July 2000, must be adhered to. Any increase in the budget deficit or the public debt are likely to halt and even reverse the downward trend of the real rate of interest in the bond market and the rate of interest on mortgages, as the government will need to increase its borrowing. Such fiscal expansion may also undermine the prevailing stability in Israel’s markets, against the background of the tremors felt in the financial stability of several other countries. The Bank of Israel notes that since the beginning of 2000 the rate of interest has been reduced by 4.4 percentage points (from 10.7 percent to 6.3 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 about 3.5 percentage points, and is currently about 5 percent, its lowest level in the last two years. 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 if the obligation to stick to the reducing deficit targets and to lower the public debt-and the interest payments it entails-is honored. The annual 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), the same as last month’s levels. The NIS-dollar interest-rate differential is currently about 2.5 percentage points, and it has risen slightly in the first half of 2001 from its level in the second half of 2000. The further narrowing of interest-rate differentials could result in the adjustment of the public’s assets and liabilities portfolio and via its effect on the exchange rate could have an impact on the rate of inflation. Note that differentials in expected returns on financial assets are also affected by non-uniform tax rates in different channels, and steps should be taken to bring tax rates into line (without changing total tax collection on financial assets), which will improve the functioning of the financial 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
July
-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
3.75**
2.75
July
6.3
* 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 July 21 for its regular
review of interest-rate policy. The current Federal Reserve rate of interest, prior to the review, is 3.75 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 a

Effective b

Real c

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

July

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

7.3

5.8

4.4

July

6.5

6.8

5.0

 

July

6.3

 

 

 

a Simple (not compound) interest, calculated in annual terms. b Calculated from the interbank rate of interest, compounded daily. c Real rate of interest is the effective rate of interest minus inflation expectations derived from the capital market.