The Bank of Israel's Monetary Program for November 2001

29 October, 2001

Monetary program for November 2001
The Bank of Israel today announced its monetary program for November 2001, according to which its interest rate will be reduced by 0.2 percentage points to 6.1 percent. The Bank of Israel explains that most assessments of inflation for the next few years-those derived from the capital market, assessments by private forecasters, and those obtained from some of the models developed in the Bank-fall within the long-term target range. The cut in the rate of interest is thus consistent with the achievement of the target in the coming years. The concern regarding future inflation in Israel which was evident following the terrorist attack on the US, reflected by a rise in inflation expectations in the markets and the development of the exchange rate in September, was not realized. In October the assessments went down again to within the target range, and fluctuations in the foreign-exchange market moderated. The Bank of Israel considers that at this stage, despite indications of increases in the budget deficits this year and next, the short-term rate of interest can be cut, to provide support for real economic activity without jeopardizing the attainment of the long-term inflation target. As is known, monetary policy aims to maintain the target of price stability set by the government, providing the necessary infrastructure for sustainable growth and bolstering the financial stability of the money, capital, and foreign-currency markets. This stability withstood the test of recent events in world capital markets in the wake of the attack on the US, and it is important to continue fostering it in view of increased uncertainty resulting from the external and domestic factors to which Israel is exposed. The Bank of Israel stressed that the only way to encourage export- and investment-led growth, i.e., sustainable growth, is by maintaining price stability. Undermining price stability would have an adverse effect on investment and increase the balance-of-payments deficit, particularly in view of the rise in the budget deficit this year and that expected next year too. The rise in the deficit pushes up the cost of raising capital in Israel, and is likely to increase the cost of government and business-sector borrowing abroad, thereby harming investment and growth. The Bank of Israel adds that there is a serious lack of clarity regarding the government's budget policy for next year, and there is concern about the size of the deficit in 2002 in the event that growth does not reach the forecast figure on which the budget is based. Fiscal expansion and the rise in the deficit and in the government's domestic borrowing in 2001 and 2002 will be reflected by a further increase in its already high interest-payment burden, and this would be incurred to finance the rise in current expenditure. The risk premium which international capital markets ascribe to Israel's economy rose in October and is currently estimated at 1.1 percentage points (for half a year) and 2.0 percentage points (for 10 years). The rise in the risk premium is related to increased uncertainty in Israel and world wide following the terrorist attack on the US, and runs counter to the downward trend evident in the previous months. The interest-rate differential against the dollar is currently 3.8 percentage points, following the reduction of 0.5 of a percentage point in the US interest rate in October.
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 (percentage 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 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
-0.4
-
2.8
July
-0.3
-0.25
2.75
August
-0.2
-0.25
2.8
September
0.0
-0.5
3.3
October
0.0
-1.0
4.3
November
0.0
-
-
Interest level in January 2001 (percent, 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
August
6.3
3.5
2.8
September
6.3
3.0
3.3
October
6.3
2.5**
3.8
November
6.1
* 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 2.0 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.
** On November 6, 2001 the "Open Market Committee" of the US Federal Reserve is set to convene, for its ordinary discussion on the interest policy. The current US Federal Reserve interest, prior to this discussion, is 2.5%.

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
Real yield to redemption on CPI-indexed 10-year bonds
Realc
Effectiveb
Headline rate (simple) a
5.2
8.6
11.4
10.7
2000 January
5.2
7.8
10.9
10.3
February
5.1
7.8
10.5
9.9
March
5.1
7.0
10.1
9.6
April
5.1
6.0
9.9
9.3
May
5.2
6.1
9.9
9.3
June
5.4
7.1
9.8
9.3
July
5.6
7.3
9.6
9.1
August
5.7
6.9
9.4
8.9
September
5.6
6.9
9.1
8.6
October
5.6
7.0
8.9
8.4
November
5.8
7.8
8.6
8.2
December
5.6
7.0
8.4
8.0
2001 January
5.3
6.0
8.1
7.7
February
5.1
5.8
7.9
7.5
March
5.0
6.2
7.6
7.2
April
4.7
6.3
7.6
7.2
May
4.3
5.5
7.4
6.8
June
4.4
4.6
6.8
6.5
July
4.5
3.6
6.6
6.3
August
4.6
2.9
6.6
6.3
September
4.6
3.6
6.6
6.3
October
 
6.1
November

a Calculated in annual terms.
b Calculated as the daily compound interest rate, based on the interbank rate (se explanation in BOI no. 2).
c Real rate of interest is the effective rate of interest minus inflation expectations derived from the capital market.