The Bank of Israel's Monetary Program for April 2002

25.03.02


The Bank of Israel's Monetary Program for April 2002

The Bank of Israel today announced its monetary program for April 2002, according to which its interest rate will not be changed and will remain 4.4 percent.

The Bank of Israel explains that following the 0.6 percent interest-rate hike in March, which helped to stabilize the foreign-currency markets, inflation expectations for the next few years-derived from the capital markets, private forecasters' predictions, and inflation estimations derived from the models developed in the Bank of Israel-declined to within the target ranges of 2-3 percent for 2002 and 1-3 percent from 2003 onwards. Indications that the effect on inflation of the depreciation evident since the beginning of the year has concluded reinforce the view that price rises at the beginning of the year will not develop into an acceleration of the inflation rate. Consequently, it is possible to maintain price stability without changing the interest rate.

The Bank of Israel stresses that monetary policy aims to maintain price stability as an essential element of sustainable growth, as well as to reinforce the financial stability of the money, capital, and foreign-exchange markets. This stability, which contributes to economic robustness, requires adherence to fiscal and monetary discipline.

The Bank adds that in 2002, too, the government deficit is expected to be higher than planned. This increase requires a rise in net borrowing by the government in order to finance the deficit, thereby increasing its debt-servicing costs. Thus, for example, the interest on unindexed 10-year government (Shahar) bonds sold to the public rose again, to stand at 6.9 percent, and is now slightly higher than the cost of net borrowing by the government before the change in economic policy announced in December 2001. The object of that change was, as noted, to lower interest rates for all terms in order to encourage investment and boost employment. This response of the markets is inter alia the outcome of the expected deviation in the 2002 deficit, and embodies negative repercussions for the following aspects:

a. The government debt/GDP ratio, constituting a present and future burden on the economy that consigns budget resources to debt repayment and interest servicing at the expense of allocating resources to growth-stimulating objectives and other crucial purposes.

b. The stimulation of investment and employment, in view of the effect of the rise in long-term interest on business-sector investment and on home-buyers' mortgages, which are related to government-debt interest rates.

c. The Bank of Israel's ability to keep short-term interest low over time while maintaining price stability. The Bank of Israel explains that adhering to a budget framework that ensures low long-term interest rates and a declining government debt/GDP ratio is a necessary condition for maintaining price stability in the long run.

The change in economic policy at the end of 2001 resulted in the adjustment of the public's asset portfolio, as the NIS depreciated by 8-10 percent against the dollar. This depreciation was checked during February, and according to various indications (including the cessation of purchases and even redemptions from the mutual funds specializing in foreign-currency-indexed channels) the current stage of the process of portfolio appears to have been concluded. The rise evident since the beginning of the year in the implied volatility of Bank of Israel dollar options, indicating the fluctuations in the market, has also stopped, constituting a further indication of stability. Israel's risk premium, measured via government bonds traded abroad, dipped 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.

The Bank of Israel also points out that in the context of the debate on amending the Bank of Israel Law, the Bank continues to support the government's objectives of stimulating economic growth and employment, subject to the maintenance of price stability. In this framework, the commitment to price stability is a long-term one and should not be examined in terms of a calendar year. This approach enables allowance to be made for factors that cause temporary deviations from the path of prices at various points during the year but do not permanently undermine price stability. In this way, too, the decision on the short-term interest rate supports a policy whose aim is sustainable growth. This statement can assume added significance in 2002 if it transpires that the price increase at the beginning of the year is indeed nonrecurring.

 

Changes in NIS and dollar interest rates

 

 

ISRAEL

US

Differential between NIS and dollar interest rates*

(percentage points)

Interest level (percent, annual rate)

 

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 (percentage points)

 
2001      

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

2002      

January

-2.0

-

2.05

February

0.0

-

2.05

March

0.6

-

2.65

April

0.0

-

2.65

Interest level (percent, annual rate)

 
2001      

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

2002      

January

3.8

1.75

2.05

February

3.8

1.75

2.05

March

4.4

1.75

2.65

April

4.4

**1.75

2.65

* The comparison of interest rates requires reference also to Israel's country risk, which according to international capital markets now ranges from 0.90 percent percentage point (for half a year) to 1.50 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, by developments in financial markets abroad and by changes in the degree of tradability in those markets


** The Open Market Committee of the US Federal Reserve is set to convene on 7 May 2002 for its regular review of interest-rate policy. The current Federal Reserve of interest-rate policy, The current FederalmReserve rate of interest, prior to revew, 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

Yield on Shahar unindexed fixed-rate 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

6.6

June

6.8

7.3

5.5

4.3

6.5

July

6.5

6.8

4.6

4.4

6.8

August

6.3

6.6

3.6

4.5

7.4

September

6.3

6.6

2.9

4.6

8.1

October

6.3

6.6

4.1

4.7

7.3

November

6.1

6.4

5.0

4.7

6.9

December

5.8

5.6

4.0

4.3

6.7
2002          

January

3.8

4.0

1.1

3.7

6.6

February

3.8

4.0

0.6

3.9

6.7

March

4.4

4.6

2.0

4.3

6.9

April

4.4

       


a Announced interest rate in simple annual terms (excluding compound interest).

b Calculated as the daily compound interest rate, based on the interbank rate (see explanation in BOI no. 6).

c The real rate of interest is the effective rate of interest less inflation expectations derived from the capital market.