The Bank of Israel's Monetary Program for September 2003

25.08.03

The Bank of Israel's Monetary Program for September 2003

The Bank of Israel today announced its monetary program for September 2003, according to which the interest rate will be reduced by 0.5 percentage points to 6.5 percent.

The continuation of the process of reducing the interest rate is made possible by the fact that the level of one-year inflation expectations is within the government's price-stability target of 1-3 percent; at the same time the current background is made up of the continued decline in the rate of actual price rises, the stabilization of real activity at a modest level, and the relative calm in the foreign currency, money and capital markets. This calm prevailed despite a certain rise in the exchange rate and in nominal and real long-term yields in the last few weeks.

One-year inflation expectations derived from the capital market in August remained at a similar level to that in July, and expectations for the second year ahead and beyond rose slightly, but most of them are still in the upper part of the target range. Private forecasters' predictions of 12-month inflation are in the middle of the target range, 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 interest policy is directed towards achieving durable price stability in accordance with the government's decision that set the inflation target for 2003 and thereafter—and not necessarily for any particular calendar year—at between 1 and 3 percent (defined as price stability). Accordingly, the Bank of Israel's policy at all times in the year is aimed at attaining price stability over a period of one and two years forward.

In the last two months, with the cuts in the Bank of Israel interest rate, real and nominal long-term yields rose, after a persistent decline since February 2003 that was supported by the reduced uncertainty on the regional security and political front and the confirmation of the loan guarantees by the US government. It is not yet clear whether the change evident in the last two months in the trend in the exchange rate—from appreciation to depreciation—and in real and nominal long-term yields, from decline to a rise, is a temporary deviation from the trend of stability that has characterized the markets. In the current regime of convergence to price stability, temporary deviations above and below the range of price stability may be tolerated without an immediate response via the interest rate, provided the assessment is that other factors are acting to bring the prices path back to the target. In the currently prevailing circumstances, these factors could be the slowdown in the economy and a credible fiscal policy for 2004 that will bring the rates of the deficit and debt back onto a downward path.

Although the most recent economic package did halt the fiscal deterioration, the expected budget deficit in 2003 of 6 percent of GDP is high by any international standards and is inconsistent with government decisions to strive to return to a downward path for the deficit and the share of debt in GDP. Hence government decisions regarding the size of the budget and the deficit for 2004 will constitute a crucial test of the government's fiscal control. The absence of a suitable budget cut and a lack of determination to revert to a downward deficit path that express fiscal discipline are likely to lead to a continuation of the rise in real and nominal long-term yields, indications of which have been evident recently, and this would damage the economy's chances of returning to a path of growth and increased employment. In this context, it is unreasonable to assume that the markets will come to terms with a reality in which the Bank of Israel's interest rate is falling while long-term interest rates are rising.

The Bank of Israel keeps a watchful eye on exchange-rate developments, and in particular analyses their implications for the inflation rate, but the exchange rate at any level, its trend and its volatility do not in themselves constitute a target for monetary policy. Capital flows into and out of the economy, which have slowed in the last two months, are affected inter alia by interest rates for different terms in the markets in Israel and abroad, changes in which do not necessarily coincide with interest-rate changes determined by central banks.

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.


Table 1: Interest rates in Israel and the US

End of year

Central banks' interest rates

Yield spread between US and Israel 10-year govt. bonds c

Israel

US

Differential between central banks' interest rates b

Interest ratea

Change

Interest rate

Change

1998

13.5

-

4.75

-

8.75

-

1999

11.2

-

5.50

-

5.70

-

2000

8.2

-

6.50

-

1.70

-

2001

5.8

-

1.75

-

4.05

1.6

2002

9.1

-

1.25

-

7.85

6.8

Monthly data

 
 
 
 
 
 

2002 April

4.4

0.0

1.75

-

2.65

2.9

May

4.6

0.2

1.75

-

2.85

3.9

June

7.1

2.5

1.75

-

5.35

5.5

July

9.1

2.0

1.75

-

7.35

4.7

August

9.1

0.0

1.75

-

7.35

5.1

September

9.1

0.0

1.75

-

7.35

6.6

October

9.1

0.0

1.75

-

7.35

7.8

November

9.1

0.0

1.25

-0.50

7.85

7.4

December

9.1

0.0

1.25

-

7.85

6.8

2003 January

8.9

-0.2

1.25

-

7.65

7.5

February

8.9

0.0

1.25

-

7.65

7.9

March

8.9

0.0

1.25

-

7.65

7.0

April

8.7

-0.2

1.25

-

7.45

5.6

May

8.4

-0.3

1.25

-

7.15

5.0

June

8.0

-0.4

1.25

-

6.75

4.7

July

7.5

-0.5

1.25

-0.25

6.50

4.1

August

7.0

-0.5

1.00 d

6.00 
  4.3

September

6.5

-0.5

 

 
 
 

 

a
The rate of interest set in the previous month's monetary program for the month indicated in the table.
b
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 1.40 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.
c
c The yield spread between 10-year Shahar bonds and 10-year US government bonds.
d
The Open Market Committee of the US Federal Reserve is due to convene on 16 September 2003 for its regular review of interest-rate policy. The current Federal Reserve rate of interest, prior to the review, is 1.00 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 
6.8
7.1 
4.6
7.9 

July

7.5

7.9 
5.4
6.7 
4.4 
8.0

August

7.0

7.4 
 5.1
6.7 
4.7 
8.6 

September

6.5

 
 
 
 
 

*
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. 2, p. 17).
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.