The Bank of Israel's Monetary Program for October 2003

22.09.03

The Bank of Israel's Monetary Program for October 2003

The Bank of Israel today announced its monetary program for October 2003, according to which the interest rate will be reduced by 0.4 percentage points to 6.1 percent. This brings the cumulative reduction in the Bank of Israel's interest rate since December 2002 to 3.0 percentage points.

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 price-stability target of 1-3 percent, against the background of a moderate rate of actual price increases, the stabilization of real activity at a modest level, and the relative calm in the foreign currency, money and capital markets.

One-year inflation expectations derived from the capital market in September remained at a similar level to that in August, at about the middle of the target range (a little below 2 percent), and expectations for the second year ahead and beyond are still in the upper part of the target range. Private forecasters' predictions of 12-month inflation rose slightly, but are also 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. In accordance with the government's decision taken in 2000, the interest policy is directed towards achieving long-term price stability and not necessarily for any particular calendar year. 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 month the rise in real and nominal yields on government bonds that had started in July halted. These yields had declined between February and June 2003 due partially to the reduced uncertainty on the regional security and political front, the confirmation of the loan guarantees by the US government, and the government's economic program for 2003. The current stabilization apparently reflects a waiting position in the financial markets in their assessment of decisions regarding the 2004 budget and the possible effects of uncertainty related to the security situation on the renewal of economic activity.

The government's budget for 2004 must clearly indicate a convergence to a downward trend for the deficit and government debt. It would be appropriate in this context for the government to adopt a system of monthly monitoring of budget performance and of attainment of deficit targets to enable deviations, if any, to be rectified during the year. According to Bank of Israel estimates, the probability of achieving the deficit target for 2004 of 4 percent of GDP is low, but even that deficit level means a rising share of government debt in GDP. In addition, it is unclear whether the overall program of infrastructure investment and the plan for reducing the number of foreign workers by raising the cost of employing them can be implemented. The budget as approved contains some positive steps that have long-term implications and that help provide a basis for stability and lead the economy back to growth. On the other hand, whittling away at the budget framework while approving it and a lack of determination to revert to a downward deficit path that reflects fiscal discipline are likely to undermine stability and lead to a rise in nominal and real long-term yields, obstructing the process of economic recovery. It is unreasonable to assume that the markets will accept an ongoing situation in which the Bank of Israel's interest rate is coming down while long-term interest is 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 policy to foster employment and shorten the recession.

Table 1: Interest rates in Israel and the US

 

Central banks' interest rates

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

 

Israel

US

Differential between central banks' interest rates b

 

End of year

 

Change

Interest rate a

 

Change

Interest rate

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

0.0

4.4

-

1.75

2.65

2.9

May

0.2

4.6

-

1.75

2.85

3.9

June

2.5

7.1

-

1.75

5.35

5.5

July

2.0

9.1

-

1.75

7.35

4.7

August

0.0

9.1

-

1.75

7.35

5.1

September

0.0

9.1

-

1.75

7.35

6.6

October

0.0

9.1

-

1.75

7.35

7.8

November

0.0

9.1

-0.50

1.25

7.85

7.4

December

0.0

9.1

-

1.25

7.85

6.8

2003 January

-0.2

8.9

-

1.25

7.65

7.5

February

0.0

8.9

-

1.25

7.65

7.9

March

0.0

8.9

-

1.25

7.65

7.0

April

-0.2

8.7

-

1.25

7.45

5.6

May

-0.3

8.4

-

1.25

7.15

5.0

June

-0.4

8.0

-

1.25

6.75

4.7

July

-0.4

7.5

-0.25

1.00

6.50

4.1

August

-0.5

7.0

-

1.00

6.00

4.3

September

-0.5

6.5

-

1.00d

5.50

4.0

October

-0.4

6.1

 
 
 
 

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 0.90 percentage points (for half a year) to 1.25 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

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 28 October 2003 for its regular review of interest-rate policy. The current Federal Reserve rate of interest, prior to the review, is
1.00 percent.

Table 2: The Bank of Israel Real Rate of Interest, the Yield on Treasury Bills and on Shahar Bonds, 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

 

Effective b

 

Real c

2002      January

3.8

4.0

1.7

4.3

3.8

6.6

February

3.8

4.0

0.9

4.7

4.0

6.7

March

4.4

4.6

2.5

5.3

4.5

6.9

April

4.4

4.6

2.1

6.0

5.0

7.6

May

4.6

4.9

1.5

6.7

5.3

9.2

June

7.1

7.3*

2.7*

8.7

5.4

11.8

July

9.1

9.7

7.0

9.0

5.4

9.3

August

9.1

9.6

7.8

8.8

5.5

9.3

September

9.1

9.6

7.1

8.9

5.7

10.4

October

9.1

9.7

6.4

9.3

5.8

11.7

November

9.1

9.6

6.6

8.9

5.8

11.5

December

9.1

9.6

7.2

7.9

5.7

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

8.0

July

7.5

7.9

5.4

6.7

4.4

8.0

August

7.0

7.4

5.4

6.6

4.7

8.6

September

6.5

6.9

5.0

6.3

4.6

8.4

October

6.1

 
 
 
 
 

*

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.