The Bank of Israel's Monetary Program for December 2001

26 November, 2001

Monetary program for December 2001

The Bank of Israel today announced its monetary program for December 2001, according to which its interest rate will be reduced by 0.3 percentage points to 5.8 percent. The Bank of Israel explains that assessments of inflation for the next few years— those derived from inflation expectations in the capital market, assessments by private forecasters, and those obtained from some of the models developed in the Bank—have declined again, and are currently within the long-term target range, and some of them are even lower than the target for 2002. The cut in the rate of interest for December is thus consistent with the achievement of the target for 2002 and the next few years. In the light of these developments, the Bank of Israel considers that at this stage, despite the significant deviation of the budget deficit from its target this year and that expected in 2002, the short-term rate of interest can be reduced, to continue providing support for real economic activity as the recessions takes deeper hold, 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, which contributes to the strength of the economy, withstood the test of recent events in world capital markets in the wake of the terrorist attacks on the US, and makes it necessary to persist in maintaining fiscal and monetary discipline. The Bank of Israel advises that due to the turnaround in the economic situation arising from the worldwide slowdown and the reality of the security situation in Israel, it supports the formulation of a coordinated economic policy to encourage growth and employment. In this context it is important to change the composition of the budget by increasing the infrastructure investment element and the incentive to work rather than increasing transfer payments. This must be done while reverting to a downward budget-deficit path to enable the process of lowering the rate of interest to continue. Related to this is the need to change the wages structure in the public sector, adjusting wage drift to the low-inflation environment, to reduce the real burden imposed on the budget especially at a time of economic slowdown. It is therefore recommended that the minimum wage be adjusted according to the Consumer Price Index, plus a certain additional rate which will reflect the rise in productivity, and that the Law be enforced. The number of foreign workers should be reduced, in particular those who are in Israel illegally. These steps, together with the maintenance of stability and the implementation of structural changes in the financial markets, will make it easier for the economy to get through the period of recession in domestic and foreign demand, and will place it in a more favorable position for renewed, sustainable, investment- and export-oriented growth. The Bank of Israel stresses that the rate of interest has been reduced by more than 5 percentage points in the last two year (from 11.2 percent to 5.8 percent), and it is now at its lowest level for many years. The real short-term rate of interest, i.e., the Bank’s interest rate minus inflation expectations derived from the capital market, has also declined, and in October it stood at 4 percent, compared with 8 percent two years ago. In contrast, long-term real interest (i.e., the real yield on 10-year government bonds) has fallen relatively slowly in the last two years (from 5.2 percent to 4.7 percent). One relevant factor is the increase in government borrowing via tradable bonds in 2001 (about NIS 11 billion, compared with a planned amount of less than NIS 4 billion), due to the rise in the government deficit. This interest serves as a basis for interest on long-term loans, including mortgages and the financing of long-term projects, and is therefore an important element in economic growth.
The risk premium which international capital markets ascribe to Israel’s economy remained at the same level of about 1.1 percentage points for half a year and the premium for 10 years declined to 1.75 percentage points. The dip in the risk premium is apparently related to reduced uncertainty regarding the future worldwide and in Israel following the heightened uncertainty in the wake of the terrorist attacks on the US. The short-term interest-rate differential against the dollar is currently 4.0 percentage points, following the reduction of 0.5 of a percentage point in the US interest rate in October. The interest differential for 10 years is lower: interest on US government bonds is currently 4.6 percent, while the yield on unindexed Israel government bonds for the same period is 6.8 percent.
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
3.7
November
-0.2
-0.5
4.1
December
-0.3
-
-
Interest level in 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**
3.7
November
6.1
2.0**
4.1
December
5.8
-
-
* 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 1.75 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 December 11 for its regular review of interest-rate policy. The current Federal Reserve rate of interest, prior to the review, is 2.0 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
Real yield to redemption on CPI-indexed 10-year bonds
Realb
Effectivea
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
4.7
4.1
6.4
6.1
November
5.8
December
a Calculated in annual terms. b Calculated as the daily compound interest rate, based on the interbank rate (see explanation in BOI no. 2).. c Real rate of interest is the effective rate of interest minus inflation expectations derived from the capital market.