The Bank of Israel's Monetary Program for June 2003

26.05.03

The Bank of Israel's Monetary Program for June 2003

The Bank of Israel today announced its monetary program for June 2003, according to which the interest rate will be reduced by 0.4 percentage points, to 8.0 percent.

In the last few months, the decline in one-year inflation expectations derived from the capital market persisted, and they are close to the lower limit of the government's price-stability target (1-3 percent). Inflation expectations for the second year ahead and beyond have also declined, and for most years are now within the target range. Private forecasters' predictions of 12-month inflation are within the range of 1-2 percent, and the models developed by the Bank of Israel indicate that it is possible to attain the inflation target for the coming year and the following year while continuing to reduce the interest rate. The reduction in risk was reflected in the strengthening of the NIS in the last few months and in the continued reduction of the interest rates on unindexed long-term government bonds to about 8.5 percent, down from its peak of about 11.7 percent in February 2003. These developments may be explained mainly by the reduced regional political uncertainty following the conclusion of the war in Iraq and confirmation of the guarantees from the US government. Nevertheless, there is still considerable uncertainty regarding the effects of the implementation of the government's economic program and there is concern that despite the budget cuts, the deficit this year and in the next few years will be higher than the path set by the government. If this does occur, long-term interest will be unable to achieve its full potential reduction, which is necessary to encourage investment and growth in the economy.

Although the economic program halts the deterioration of the fiscal situation, nevertheless in the light of the temporary nature of the cuts in some budget items (and the acceptance of a government deficit of 5 percent of GDP in 2003), the program does not ensure convergence to a downward path for the deficit and for the debt/GDP ratio, and at this stage is inconsistent with the government decision to adhere to the downward path of the deficit from 3 percent of GDP in 2003 to one percent in 2007. In planning the budget for 2004, therefore, the government must revert to the deficit targets set and to a downward-sloping path for the debt/GDP ratio. Fiscal discipline is an essential requisite for the ability to attract sources from private savings into investment and credit, 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. Structural reforms passed by the government, the implementation of which can boost economic growth, are of great importance. In this context, the pensions reform that diverts the pension funds into the capital market with the intention of encouraging investment and growth will be unable to attain its objective without a reduction in the government deficit, which will enable sources of finance to be allocated to private-sector investments. Further cuts in the short-term interest rate while maintaining price stability depend to a great extent on 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.

The Bank of Israel keeps a watchful eye on exchange-rate developments, and in particular analyses their implications for the inflation rate, but it is a long time since the exchange rate at any level, its trend, or its volatility have in themselves constituted targets for monetary policy. Furthermore, the high level of functioning of the foreign-currency market currently encourages the development of financial instruments that provide protection against exchange-rate risk, thus offering companies and individuals improved protection against the risks inherent in the natural volatility of the market. This trend of hedging against risks of exchange-rate volatility has in fact been evident in the behavior of the business sector, including exporters, in the last few years.

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

-

7.15

June

-0.4

-

 

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

May

8.4

  1.25***
  7.15

June

8.0

   

 

* 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 1.40 percentage points (for half a year) to 1.6 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 25 June 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 
 9.5

May

8.4

8.9 
7.9 
7.6 
5.0 
8.5 

June

8.0

 
 
 
 
 

* 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.