The Bank of Israel's Monetary Program for July 2003

23.06.03

The Bank of Israel's Monetary Program for July 2003

The Bank of Israel today announced its monetary program for July 2003, according to which the interest rate will be reduced by 0.5 percentage points to 7.5 percent.

This reduction in the interest rate was made possible by the reduction in one-year inflation expectations, the continued calm in the foreign-currency market and in the money and capital markets, and the drop in the rate of actual price rises. In the last two months, one-year inflation expectations derived from the capital market stabilized, and they are below the middle of the government's price-stability target of 1-3 percent. Inflation expectations for the second year ahead and beyond continued to decline, and are now in the upper part of 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. It is important to bear in mind that the interest policy is directed towards the achievement of price stability for the coming year and for the years thereafter, and not necessarily within a particular calendar year. 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 8.0 percent, down from about 11.7 percent in February 2003, and in the reduction of more than one percentage point in the yield on 10-year indexed government bonds in that same period, to 4.7 percent. These developments may be explained mainly by the reduced regional political uncertainty following the conclusion of the war in Iraq, the confirmation of the loan guarantees by the US government and as part of the worldwide trend of improved demand for bonds in emerging markets. Nevertheless, there is still a feeling of uncertainty, and it seems that despite the budget cuts that accompanied the approval of the economic package, the deficit this year and in the next few years will be significantly 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, and under certain circumstances this could constitute a source of instability.

Although the economic program halts the deterioration of the fiscal situation, nevertheless the acceptance of a government deficit of between 5 and 6 percent of GDP in 2003 and similar assessments regarding the deficit in 2004-which is high by all international standards-do not indicate convergence to a downward path for the deficit and for the debt/GDP ratio, and are inconsistent with the government decision to adhere to the downward deficit path from 3 percent of GDP in 2003 to 1 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. It must be borne in mind that a rise in the debt means a rise in the tax burden in the future. 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. 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 and to return to a downward-sloping deficit and debt path which are 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. High volatility has been evident in the market in the last few months, reflected in a rise in the risk premium as calculated from the NIS/$ options issued by the Bank of Israel, as well as in a rise in the intraday volatility and in the margins between banks' foreign-currency buying and selling prices. Foreign-currency markets throughout the world are highly volatile, sometimes exhibiting sharp trend reversals, and the market in Israel, which is highly developed, is similar in this respect to the international markets.

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

-

6.75

July

-0.5

-

 

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

  1.25***
 6.75

July

7.5

   

 

* 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 1.30 percentage points (for 10 years), reductions of 0.30 and 0.20 percentage points respectively in the last month (updated data). 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
7.2 
 8.2
5.4 
 9.5

May

8.4

8.8 
7.4 
7.6 
5.0 
8.5 

June

8.0

8.4 
 7.1
7.2 
4.7 
8.0 

July

7.5

 
 
 
 
 

* 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.