The Bank of Israel's Monetary Program for February 2002

28.01.02

The Bank of Israel's Monetary Program for February 2002

The Bank of Israel today announced its monetary program for February 2002, according to which its interest rate will remain at its present level of 3.8 percent.

The Bank of Israel explains that although inflation expectations for the next few years-those derived from the capital markets, private forecasters' predictions, and inflation estimations derived from some of the models developed in the Bank of Israel-have risen, most of them are at the upper limit of the target ranges of 2-3 percent for 2002 and 1-3 percent from 2003 onwards. Despite the evident rise in the degree of uncertainty in the financial markets, there are indications that against the background of the reduced level of economic activity, the changes in the exchange rate are likely to result in a one-time rise in prices, and not a return to a path of inflation. At this stage, therefore, it is possible to maintain price and financial stability without changing the interest rate.

Monetary policy is aimed at preserving price stability set by the government as its target-a sine qua non for sustainable economic growth and for strengthening financial stability in the money, capital and foreign-currency markets. This stability, which adds to the soundness of the economy, requires the maintenance of fiscal and monetary discipline.

The Bank of Israel reduced the interest rate at the end of 2001 by an exceptional two percentage points as part of a change to the mix of economic policy, which included a government decision to revert to a tight fiscal policy and a declining path for the budget deficit and government debt in the next few years. The importance of reducing the deficit and government debt and their effect on long-term interest rate and on the stability of the financial and foreign-currency markets must be emphasized. The budget deficit decided upon for 2002, three percent of GDP, must therefore be adhered to, otherwise uncertainty-which has risen recently due to the worldwide recession and the security situation-will increase further, and will make it more difficult to recover from the recession and boost employment even when the external conditions are more favorable. Moreover, if stability in the foreign-currency market is not achieved, and if medium- and long-term interest rates rise as a result of the budget deficit exceeding the level set for it and expectations that the deficit will continue to increase, then the short-term interest rate will have to be adjusted in order to preserve price stability.

The Bank adds that the change in economic policy at the end of 2001 has so far led to a relatively moderate adjustment in the public's assets portfolio, and this took the form mainly of purchases by households of mutual funds specializing in foreign-currency investments. This reaction is natural in the light of the change in the differential between interest on the NIS and that on the dollar, and was reflected, among other things, by the 7-8 percent rise in the NIS/$ exchange rate. As the exchange rate rose, so did its volatility, and the standard deviation-derived from the prices of Bank of Israel options-rose from 5.0 percent to 7.0 percent. Note, however, that higher standard deviations than this are normal on foreign-currency markets abroad. The Bank of Israel adds that the rise in the exchange rate took place with a high level of trade, which indicates the market's increased sophistication.

Israel's risk premium, measured via government bonds traded abroad, fell slightly; it is difficult to use this as a guide to foreign investors' assessments of Israel's risk, however, due to the heavy involvement of Israeli investors in these markets and the low level of tradability.

Changes in NIS and dollar interest rates

 

 

ISRAEL

US

Differential between NIS and dollar interest rates*

(percentage points)

Interest level (percent, annual rate)

 

December 1998

13.50

4.75

8.75

December 1999

11.20

5.50

5.70

December 2000

8.20

6.50

1.70

December 2001

5.80

1.75

4.05

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

-

2.8

July

-0.3

-0.25

2.75

August

-0.2

-0.25

2.80

September

0.0

-0.50

3.30

October

0.0

-0.50

3.80

November

-0.2

-0.50

4.10

December

-0.3

-0.25

4.05

Changes in interest rate in 2002 (percentage points)

 

January

-2.0

-

2.05

February

-

-

2.05

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

2.80

September

6.3

3.0

3.30

October

6.3

2.5

3.80

November

6.1

2.0

4.10

December

5.8

1.75

4.05

Interest level in 2002 (percent, annual rate)

 

January

3.8

1.75

2.05

February

3.8

**1.75

2.05

*  The comparison of interest rates requires reference also to Israel's country risk, which according to international capital markets now ranges from 0.80 percent percentage point (for half a year) to 1.40 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 30 January 2002 for its regular review of interest-rate policy. The current Federal Reserve rate of interest, prior to the review, is
1.75 percent.

 

The Bank of Israel Real Rate of Interest

and the Real Yield on CPI-Indexed Government Bonds

(monthly average, percent)

 

Bank of Israel rate of interest

 
 

Headline rate (simple)a

 

Effectiveb

 

Realc

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

7.3

5.5

4.3

July

6.5

6.8

4.6

4.4

August

6.3

6.6

3.6

4.5

September

6.3

6.6

2.9

4.6

October

6.3

6.6

4.1

4.7

November

6.1

6.4

5.0

4.7

December

5.8

5.6

4.0

4.3

2002     January

3.8

4.0

1.1

3.7

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.