The Bank of Israel's Monetary Program for March 2003

24.02.03

The Bank of Israel's Monetary Program for March 2003

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

The Bank of Israel stated that despite the slow rate of price increases in the second half of 2002 (0.2 percent), inflation expectations for a year ahead derived from the capital market rose, and are above the inflation target set by the government (1-3 percent for 2003 and subsequently); inflation expectations derived from the capital market for two years ahead and longer have also risen, remaining above the target limit. Private forecasters' predictions are also higher, and are close to the upper limit of the target. The models developed by the Bank of Israel indicate that it is possible to attain the target of price stability at the current level of interest, provided the foreign-exchange market is calm. The overall picture, then, indicates a high level of uncertainty, expressed in both the capital and foreign-currency markets, arising from apprehensions regarding the implications of a possible war in Iraq and unanswered questions concerning the 2003 budget. In addition, the background conditions that have enveloped the economy for over two years-the continuation of the global depression and the Intifada, whose effects intensified in 2002-had a contractionary effect.

The Bank of Israel added that it is now evident that the budget approved by the Knesset in 2003 is based on an over-estimation of tax receipts, and according to the deficit figures for the beginning of 2003 the national budget is problematic. In order to prevent further expansion of the deficit and the foreign debt it is necessary to adjust the budget forthwith. Uncertainty as regards the size of the deficit in 2003, and the increase in net government borrowing to finance it, are expressed in the 11.7 percent and 5.8 percent increases in capital market yields on Shahar and Galil bonds respectively, similar to their levels in June 2002 and significantly higher than the rates prevailing at the beginning of 2002.

The Bank of Israel stressed that the new government will have to adhere to fiscal discipline by introducing substantial measures intended to reduce current expenditure in 2003 and reduce its growth rate in the coming years. This will bring it into line with the gradual reduction of taxes until 2008, increase in infrastructure investment, declining budget deficit path until 2007, and reduction of the government debt/GDP ratio. This policy is a necessary condition for making credit available in the economy, maintaining Israel's credit rating in international markets, reducing the long-term interest on government bonds, and thus lowering the interest on credit for investment and mortgages which is important for reviving growth and stimulating investment. The government must also act to restore credibility to the markets and reinforce financial stability while implementing the budget policy described above and stressing its commitment to maintaining the central bank's independence. The Bank of Israel explained that the continued reduction of short-term interest while maintaining stability, depends to a great extent on public confidence in budget discipline, which is also essential for strengthening the financial system.

The Bank of Israel added that uncertainty in the foreign-exchange market has remained high because of the intensity of the main factors adversely affecting the markets-the relaxation of fiscal restraint and apprehensions regarding the security situation. In recent months the implied volatility of the NIS/dollar options issued by the Bank of Israel, serving as a measure of the risk attributed by the market to the exchange rate, has risen and is now higher than it was in June 2002. The risk premium ascribed by the international markets to the Israeli economy has also remained high.

The Bank of Israel will continue to monitor developments in the market, in order to maintain the inflation rate defined as price stability while bolstering financial stability. Subject to these conditions, the Bank will act to support the government's policy to foster employment and shorten 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 1998

13.50

4.75

8.80

December 1999

11.20

5.50

5.70

December 2000

8.20

6.50

1.70

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

-

 

March

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

 1.25***
 7.65

March

8.9

   

 

* The rate of interest set in the previous month's monetary program for the month indicated in the table.
** The comparison of interest rates requires reference also to Israel's country risk, which according to international capital markets now ranges from 1.7 percentage points (for half a year) to 2.1 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 18 March 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 
5.9
 8.1
5.8 
 11.4

February

8.9

9.4 
 4.7
8.7 
5.7 
 11.7

March

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.