The Bank of Israel's Monetary Program for July 2002

24.06.02

The Bank of Israel's Monetary Program for July 2002

The Bank of Israel today announced its monetary program for July 2002, according to which its interest rate will be raised by 2 percentage points to 9.1 percent. Together with the two rises in the interest rate in June, the cumulative rise in this period amounts to 4.5 percentage points.

The Bank of Israel explains that the rise in the short-term interest rate is intended to bring inflation back down into the range of price stability. This step is taken against the background of the indications that financial stability is being undermined due to increased uncertainty in the financial markets caused by the ongoing looseness of budgetary discipline and by the security situation, expressed in the marked rise in long-term interest which recently resulted in a rise in short-term interest rates too.

The interest-rate hike was made necessary because, due to the rise in actual inflation since the beginning of the year and the depreciation of the NIS, inflation expectations for the next few years—as derived from the capital market, private forecasters, and the Bank of Israel's models—have also risen beyond the 3 percent rate which constitutes the upper limit of the range defined as price stability. Despite the two increases in the Bank of Israel's interest rate in June, inflation expectations for one year ahead have risen recently and reached 5 percent.

The Bank of Israel explains that to restore price stability and to stabilize the financial markets, the government must take immediate and determined steps to correct its fiscal policy so that it reverts to a downward sloping deficit path, while at the same time reducing the government debt. The exceptional rise in the interest on government bonds in the last few weeks (which brought the rate to more than 11 percent on Shahar nine-year bonds), reflects the markets' scepticism regarding the extent of the government's resolve to deal with the budget deficit at a fundamental level. It is therefore vital to change direction and institute the necessary changes in the budget immediately. Government success in passing the 'market test' will enable the economy to revert to a path of stability, which is essential for a return to growth and increased employment.

The Bank notes that the amendment to the budget for 2002 which was approved by the Knesset at the beginning of the month accepts a deficit target of 4 percent of GDP, the third upward revision to the target in the past year. In terms of the accepted international definition of the deficit this is equivalent to 7 percent of GDP, a truly worrying figure by any standard. To prevent a repetition of the persistent deviations in the deficit which occurred in the last year and a half, the budgets for 2002 and 2003 must be reduced substantially, the composition of expenditure altered so that it supports growth, and the appropriate changes made to procedures which will enable the constant monitoring of the deficit and thus its achievement.

The Bank of Israel points out that although raising the short-term interest rate may indeed bring about a certain increase in real interest, the current level of real interest is lower than that which prevailed during the last few years. The Bank expects that a return to price stability will provide a firm basis for the real depreciation that has occurred, so that this step will encourage growth and employment. Achieving stability will per se help to modify the indicated trends that the recession is deepening further, and improve Israel's economic robustness which is of such importance at times of uncertainty.

In this regard the Bank notes that as a result of the cumulative increase of 4.5 percentage points in the interest rate in the last month, the differential between the Bank's rate of interest and the dollar interest rate has widened from 2.85 percentage points to 7.35 percentage points. As is known, in the current situation short-term capital flows are affected by the interest-rate differential, and they in turn, together with other factors, affect the exchange rate. The Bank expects these measures to contribute to a lowering of the degree of uncertainty in the foreign currency market which is reflected in the rise in the price of exchange-rate options issued by the Bank and in a rise in the volatility of the exchange rate.

The Bank of Israel also advises that it will continue to act as necessary to bring the economy back into an environment of price stability and financial stability. In this context the Bank observes that other factors that should be considered when relating to economic stability include the need for fiscal policy to revert to a downward budget deficit path and a downward trend of government debt in the light of the further deterioration in the security situation, and the proposed amendment to the Bank of Israel Law brought before the Knesset which would limit the Bank's ability to act in an independent and determined manner to maintain price stability.

Changes in NIS and dollar interest rates

 

 

 

ISRAEL

 

US

Differential between NIS and dollar interest rates*

(percentage points)

Interest level (percent, annual rate)

 

December 2000

8.20

6.50

1.70

December 2001

5.80

1.75

4.05

Changes in interest rate 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

-0.4

-

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

May

0.2

-

2.85

June

2.5

-

5.35

July

2.0

-

7.35

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

0.0

1.75

2.65

May

4.6

1.75

2.85

June

7.1

1.75

5.35

July

9.1

1.75**

7.35

*  The comparison of interest rates requires reference also to Israel's country risk, which according to international capital markets now ranges from 1.10 percentage points (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 due to convene on 26 June 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, the Yield on Treasury Bills, and the Real Yield on CPI-Indexed Government Bonds

(monthly average, percent)

    

Headline rate (simple)a

Bank of Israel rate of interest

Yield on 12-month Treasury bills

Real yield to redemption on CPI-indexed 10-year bonds

Yield on Shahar unindexed fixed-rate 10-year bonds

Effectiveb

Realc

2000                  

April

9.6

10.1

7.0

8.8

5.1

-

May

9.3

9.9

6.0

9.1

5.1

-

June

9.3

9.9

6.1

9.3

5.2

-

July

9.3

9.8

7.1

9.0

5.4

-

August

9.1

9.6

7.3

8.8

5.6

-

September

8.9

9.4

6.9

8.7

5.7

-

October

8.6

9.1

6.9

8.6

5.6

-

November

8.4

8.9

7.0

8.4

5.6

-

December

8.2

8.6

7.8

7.8

5.8

-

2001                  

 January

8.0

8.4

7.0

7.6

5.6

-

February

7.7

8.1

6.0

7.3

5.3

-

March

7.5

7.9

5.8

7.1

5.1

-

April

7.2

7.6

6.2

6.8

5.0

-

May

7.2

7.6

6.3

6.6

4.7

6.6

June

6.8

7.3

5.5

6.4

4.3

6.5

July

6.5

6.8

4.6

6.2

4.4

6.8

August

6.3

6.6

3.6

6.4

4.5

7.4

September

6.3

6.6

2.9

6.7

4.6

8.1

October

6.3

6.6

4.1

6.3

4.7

7.3

November

6.1

6.4

5.0

5.8

4.7

6.9

December

5.8

5.6

4.0

5.0

4.3

6.7

2002                  

 January

3.8

4.0

1.2

4.3

3.7

6.6

February

3.8

4.0

0.8

4.7

3.9

6.7

March

4.4

4.6

2.2

5.3

4.4

6.9

April

4.4

4.6

1.3

5.7

4.9

7.6

May

4.6

4.8

0.4

6.7

5.2

9.2

June

7.1

6.3*

0.7

8.1

5.2

11.8

July

9.1

         

* Including two increases in the interest rate in the month. The Bank of Israel's effective and real interest rates are calculated on the basis of monthly averages.
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.