The Bank of Israel's Monetary Program for January 2003

23.12.02

The Bank of Israel's Monetary Program for January 2003


The Bank of Israel today announced its monetary program for January 2003, according to which the interest rate will be reduced by 0.2 percentage points to 8.9 percent.

In recent weeks there has been a decline in one-year inflation expectations as derived from the capital market, and their level is slightly below the upper limit of the inflation target set by the government (3 percent). Nonetheless, inflation expectations for two years forward and beyond are still above the upper limit of price stability, unlike the situation that prevailed at the beginning of 2002. Private forecasters' predictions for next year and assessments of inflation derived from the models developed by the Bank of Israel are also within the target range, conditional on the relative calm in the foreign-exchange market prevailing. The actual rate of inflation in the second half of 2002 also stabilized within the target range, albeit with wide fluctuations in the price indices from month to month, in contrast to the acceleration in the rate in the first half of the year. These developments enable a reduction in the interest rate without undermining price stability or financial stability. Nevertheless, the overall picture still indicates a high level of uncertainty deriving from doubts related to the budget for 2003, political uncertainty and concern regarding the effect of war against Iraq on the economy.

The 2003 budget which was passed by the Knesset is based on an over-estimate of receipts and an under-estimate of expenditure, which is likely to be reflected in a larger-than-planned deficit, a further rise in long-term interest, and a continuation of the undesirable process of a shortening of the debt. In order to prevent these from occurring, a substantial revision of the budget will have to be undertaken by the new government after the election. Investors' doubts regarding fiscal discipline, and uncertainty as to the size of the deficit this year and next, were expressed in the capital market by the yields on Shahar bonds, which reached as high as 10.8 percent in December, having declined to 9.3 percent in July and August.

Fiscal discipline and the aspiration to attain a declining budget deficit path and debt/GDP ratio are necessary conditions for the availability of credit and for a decline in long-term interest on government bonds, and hence for the reduction of interest on credit for the investments and mortgages needed for the renewal of growth and the stimulation of employment. The extent to which the cut in the Bank of Israel's short-term interest rate contributes to a decline in long-term interest, renewed growth and higher employment without harming stability, therefore depends to a great extent on fiscal discipline, which is essential also for strengthening the financial system.

Despite local-currency appreciation evident since June, there is still great uncertainty in the foreign-currency market. Although exchange-rate volatility declined slightly in November-as is seen from the implicit standard deviation of the NIS/foreign-currency options issued by the Bank of Israel, which measures the risk which the market imputes to the domestic exchange rate-it is still higher than it was in 2001. Although the risk premium ascribed to Israel by international markets-as expressed in the difference between interest on government bonds traded abroad and that on US government bonds-also declined, its level of 2.1 percent for ten years is still high compared with its level of 1.7 percent in July.

The Bank of Israel will continue to monitor developments in the market, in order to bolster financial stability and ensure that the rate of inflation is maintained within the range of between 1 percent and 3 percent a year defined as price stability, which becomes the effective target from 2003 onwards. Subject to these conditions, the Bank will act to support policy aimed at fostering employment and shortening the recession.

 

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

December 2002

9.1

**1.25

7.85

Changes in interest rate percentage points)

 

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

August

0.0

-

7.35

September

0.0

-

7.35

October

0.0

-

7.35

November

0.0

-0.50

7.85

December

0.0

-

7.85

2003 January

-2.0

-

7.65

Interest level (percent, annual rate)

 

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

August

9.1

1.75

7.35

September

9.1

1.75

7.35

October

9.1

1.75

7.35

November

9.1

1.25

7.85

December

9.1

** 1.25
7.85

2003 January

8.9

   

 

*  The comparison of interest rates requires reference also to Israel's country risk, which according to international capital markets now ranges from 1.70 percentage points (for half a year) to 2.10 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 29 January 2003 for its regular review of interest-rate policy. The current Federal Reserve rate of interest, prior to the review, is 1.25 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
9-10-year bonds d

Effective b

Real c

2000                  

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

6.0

4.9

7.6

May

4.6

4.9

0.4

6.7

5.2

9.2

June

7.1

7.3*

*2.2

8.7

5.3

11.8

July

9.1

9.7
6.7
9.0
5.4
9.3

August

9.1

9.6
7.5
8.8
5.5
9.3

September

9.1

9.6
6.5
8.9
5.7
10.4

October

9.1

9.7
5.5 
9.3 
5.8 
11.7 

November

9.1

9.6
5.7 
8.9 
5.8 
11.5

December

9.1

9.6 
6.7 
8.0 
5.6 
10.8 

2003

 

 
 
 
 
 

January

8.9

 
 
 
 
 

* 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.
d Up to June 2002 the yield on 10-year auctions. From July the average daily market yield.