The Bank of Israel's Monetary Program for February 2003

27.01.03

The Bank of Israel's Monetary Program for February 2003

The Bank of Israel today announced its monetary program for February 2003, according to which the interest rate will remain unchanged at 8.9 percent.

In recent weeks uncertainty has increased, as is reflected by the capital markets and the foreign-exchange market. Inflation expectations for one year ahead derived from the capital market again rose above the upper limit of the inflation target set by the government. Expectations derived from the capital market for the second year ahead and beyond also rose, and remained above the price stability level. Private forecasters' predictions also edged up a little, but remained within the inflation target range. The models developed by the Bank of Israel indicate a possibility that the target will be achieved, conditional on calm prevailing in the foreign-exchange market. It is noteworthy that assessments of future inflation rose despite a decline in actual inflation and the slow rate of price increases, 0.2 percent, in the second half of 2002 (down from 6.3 percent in the first half). The overall picture is one clouded by uncertainty deriving from uncertainty about political stability, concern regarding the effect on economic stability of war against Iraq, and doubts related to the budget for 2003. All these elements come on top of the background conditions that have persisted for more than two years—the intifada and the continued global recession.

The 2003 budget which was passed by the Knesset is based on an over-estimate of receipts, which is likely to be reflected in a larger-than-planned deficit. In order to prevent this, a substantial revision of the budget will have to be undertaken by the new government after the election. Investors' doubts regarding the government's ability to maintain fiscal discipline, uncertainty as to the size of the deficit in 2003, and increased borrowing by the government to finance the deficit were expressed in the capital market by a rise in yields on Shahar and Galil bonds, which reached 11.4 percent and 5.8 percent respectively, similar to their levels in June 2002.

The new government will have to adhere to fiscal discipline by taking significant measures to cut current expenditure in 2003 and to reduce its rate of increase in the next few years such that it will be consistent with the downward path of budget deficits until 2007 and of the government debt/GDP ratio. This policy is essential to ensure the availability of credit and the reduction of long-term interest on government bonds, and hence the reduction of interest on credit for investments and mortgages that is vital to encourage renewed growth and to boost employment. Beyond the measures approved regarding the 2003 budget, the new government will have to decide to implement a budget policy that will re-establish the credibility of the markets and bolster financial stability. The continued reduction of the short-term interest rate without undermining stability largely depends on public confidence in fiscal discipline that is also essential for strengthening the financial system.

The level of uncertainty in the foreign-exchange market rose again in the last few weeks, with the intensification of the main elements that have a negative effect on the markets—a loosening of fiscal discipline and concern about a deterioration in the security situation. In the last few months the implied volatility of NIS/dollar options issued by the Bank of Israel—which measures the risk that the market imputes to the domestic exchange rate—has risen, and is now higher than it was in June 2002. The risk premium ascribed to Israel by international markets also remained at a high level.

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 1999

11.20

5.50

5.70

December 2000

8.20

6.50

7.85

December 2001

5.80

1.75

4.05

December 2002

9.10

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

February

0.0

-

 

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

 1.25**
 7.65

February

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 2.2 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

Effectiveb

Realc

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
5.8 
8.9 
5.8 
11.5

December

9.1

9.6 
6.7 
7.9 
5.6 
10.9 

2003

 

 
 
 
 
 

January

8.9

9.4 
  6.5
 8.0
5.8 
 11.4

February

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.