Update of the Bank of Israel's Monetary Program for June 2002

09.06.02

Update of the Bank of Israel’s Monetary Program for June 2002

The Bank of Israel today announced an update of its monetary program for June 2002, according to which its interest rate will be raised by 1.5 percent to 7.1 percent. The change will go into effect on Tuesday, 11 June 2002. Thus, the overall interest-rate hike in June amounts to 2.5 percent.

The Bank of Israel explains that in the last few months there has been a rise in inflation expectations for a year ahead, and for some time now this has deviated from the upper limit of the price stability target, which is 3 percent, and has even recently reached 5 percent. The 2002 inflation rate is assessed at twice the upper limit of the price stability target, and even expectations for a year ahead indicate no convergence to the sphere of price stability.

The Bank of Israel adds that the purpose of the decision to raise the interest rate is to help restore inflation to the region of price stability and reinforce financial stability. The decision to raise the interest rate outside the usual timetable was reached as a result of the accumulation of indications attesting to a departure from the framework of price stability, among them the rise in inflation expectations for the next few years as derived from the capital market and predicted by private forecasters, the rapid and ongoing local-currency depreciation, and the increase in uncertainty as a result of the deterioration in the security situation, as well as rising long-term interest rates, which attest to the relaxation of fiscal restraint.

The Bank of Israel points out that the amendment to the 2002 budget which was passed by the Knesset a few days ago is based on a deficit target of 4 percent of GDP-the third upwards adjustment of the target this year. Using accepted international definitions, this target is equivalent to 7 percent of GDP—which gives rise to concern by any standard.

The Bank of Israel notes that while the rise in the short-term interest rate could to some extent lead to a higher real interest rate, its current level is far lower than the one that has prevailed in recent years and, together with the real depreciation that has emerged (which will be maintained only if the inflation rate is prevented from accelerating), supports growth and employment. The Bank of Israel explains that the attainment of stability in itself serves to moderate the emerging trend of deepening recession, thereby buttressing the economic robustness which is so vital at a time of uncertainty.

The Bank of Israel reiterates its intention of continuing to do all that is necessary to restore the economy to an environment of price and financial stability. In this context, the Bank stresses several factors which must be taken into consideration when addressing economic stability, namely, the failure to return to a fiscal policy of declining budget deficits and the reduction of the government debt, the proliferation of security events, and the proposed amendment to the Bank of Israel Law, as brought before the Knesset, which annuls the Bank’s ability to act independently and in a determined manner to maintain price stability.