The Bank of Israel's Monetary Program for May 2003

28.04.03

The Bank of Israel's Monetary Program for May 2003

The Bank of Israel today announced its monetary program for May 2003, according to which the interest rate will be reduced by 0.3 percentage points, to 8.4 percent.

In the last few months, one-year inflation expectations derived from the capital market declined, and at about 2 percent they are currently in the middle of the inflation target set by the government. Inflation expectations for the second year ahead and beyond have also declined by about one percentage point, but most of them are still above the target. Private forecasters' predictions of 12-month inflation have also dropped and are close to the lower limit of the target range. In addition, the models developed by the Bank of Israel indicate that it is possible to attain the target of price stability while reducing the short-term interest rate. It appears that the calm in the markets, expressed in the appreciation of the NIS and the reduction of more than one percentage point in unindexed long-term interest rates, may be explained mainly by reduced uncertainty following the rapid conclusion of the war in Iraq and progress made regarding the receipt of guarantees from the US government. Nevertheless, there is still considerable uncertainty in view of the difficulties in the implementation of budget policy and the assessment that the deficit this year and in the next few years will be higher than the path set by the government, making greater caution necessary in interest-rate policy.

There is much uncertainty about the extent to which government decisions on the size of budget cuts will be implemented. There are indications that the cuts in some budget items are only temporary and many questions remain regarding the convergence to a downward sloping deficit path and a reducing government debt/GDP ratio. Fiscal discipline is essential for the transfer of sources from private savings to investment and credit, for the preservation of Israel's rating in the international markets, for the continued reduction of long-term interest on government bonds, and hence for the reduction of interest on credit for investment and mortgages that is so important for renewed growth and the encouragement of employment. Further cuts in the short-term interest rate while maintaining price stability depend to a great extent on the public's confidence in the government's ability to ensure fiscal discipline for the current year and for the medium term, discipline that is also required to strengthen the financial system. Price stability is characterized by relatively low volatility of the monthly indices, and as yet this is not evident in Israel.

With the rapid end of the war in Iraq calm returned to the foreign currency market, reflected in NIS appreciation of some 2.6 percent in March and almost 2 percent during April (the exchange rate is similar to that in the first quarter of 2002), and in a reduction in exchange-rate risk as evidenced recently by the fall to below 8 percent in the standard deviation as measured by the prices of Bank of Israel options, compared with close to 10 percent two months ago. With the end of the Iraq war Israel's country risk premium in the markets declined: the interest-rate differentials between Israeli government bonds traded abroad and US government bonds fell by more than 50 basis points, and the premium is currently 1.0 percentage points for half a year and about 1.4 percentage points for ten years, compared with 1.6 and 2.0 percentage points respectively a month ago.

The Bank of Israel will continue to monitor developments in the markets, in order to ensure that the inflation rate defined as price stability is maintained 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 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

-

7.65

March

0.0

-

7.65

April

-0.2

-

7.45

May

-0.3

-

 

Interest level (percent, annual rate)

 

2002 April

4.4

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

 1.25
 7.65

April

8.7

  1.25***
  7.45

April

8.4

   

 

* 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 1.00 percentage points (for half a year) to 1.35 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 6 May 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

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
 8.1
5.9 
 11.4

February

8.9

9.4 
5.4
8.7 
5.8 
 11.7

March

8.9

 9.4
6.1
8.6 
5.6 
10.7

April

8.7

 9.2
7.0 
 8.2
5.4 
 9.9

May

8.4

 
 
 
 
 

* 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.