The Bank of Israel's Monetary Program for February 2004

The Bank of Israel’s Monetary Program for February 2004

 

The Bank of Israel today announced its monetary program for February 2004, according to which the interest rate will be reduced by 0.3 percentage points to 4.5 percent. This brings the cumulative reduction in the Bank of Israel’s interest rate since December 2002 to 4.6 percentage points.

 

The continuation of the process of reducing the interest rate is made possible by the fact that one-year inflation expectations are in the lower part of the price-stability target range of 1–3 percent, against the background of the actual reduction in the Consumer Price Index in the last twelve months, the continued moderate level of real economic activity, and the relative calm in the foreign currency, money and capital markets. Concurrent with the process of reducing the interest rate and narrowing the interest-rate differential between Israel and other countries, the money supply rose by almost 9 percent in the last year and the NIS depreciated by about 8 percent against the currency basket since the end of June. The continued gradual reduction of the interest rate, in the light of its current level and its reduction by more than a half since the end of 2002, has lowered short-term real interest from 7.2 percent to 4.1 percent in that period, and therefore helps to encourage growth and boost employment while maintaining price and financial stability.

 

One-year inflation expectations derived from the capital market rose slightly in January, and are currently at the lower boundary of the target range, and expectations for the second year ahead are within the target range. Private forecasters’ predictions of 12-month inflation rose slightly and are below the middle of the target range, and some of 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 slowly continuing to reduce the interest rate.

 

Changes in the composition of the public’s asset portfolio in 2003 derived inter alia from the process of interest-rate reduction by the Bank of Israel. Most prominent among the changes this year is the rise in the proportion of shares in the portfolio due to the increase in their price, which accounted for almost two-thirds of the increase in the portfolio. The decline in short- and long-term interest rates led to a rise in the value of the tradable assets portfolio, with a switch from bank deposits to investment in tradable assets which was also partly due to changes in taxation on financial assets. Furthermore, despite the marked reduction in the interest-rate differential between Israel and the rest of the world, with the continued proper functioning of the markets there has been a gradual adjustment of the shares of local-currency and foreign-currency assets; only in the last two months have there been indications of a certain rise in Israelis’ investment abroad.

 

In the last few months the decline in yields on government bonds has persisted, albeit at a slower rate: since the beginning of the year nominal yields (on 10-year bonds) have dropped by more than 4.5 percentage points to a level of about 6.9 percent, and real long-term yields by more than 2.0 percentage points to a level of about 4.0 percent. The reduction in long-term interest on government bonds apparently indicates that the public considers that the budget deficit in 2003 (which was relatively large and greater than in 2002) derives mainly from the temporary effect of the low level of economic activity in reducing the government’s tax revenues, and that it is to a lesser degree a structural deficit constituting a long-term problem.

 

Following the Knesset’s approval of the government’s budget for 2004, adhering to its framework is vital for the preservation of the stability that has been attained. The determination to return to a declining government deficit and debt path, together with the reform of the labor market and the implementation of the plans for infrastructure investment, will help to steer the economy back onto a path of growth. Departure from this path, in view of the large government debt, is likely to lead to a rise in nominal and real yields and to hamper the process of economic recovery that has recently begun to emerge.

 

The calm in the foreign currency market evident in the last two months continued, with the strengthening of the NIS relative to the dollar and its marked depreciation against the euro reflecting changes in the international currency markets. Israel’s risk premium, as measured by the 5-year credit-default-swap (CDS) market, remained at 60 basis points in January, after the downward path evident since the first quarter of 2003. The calm in the market appears to be due to the US government loan guarantees and the credibility of macroeconomic policy in the eyes of the public.

 

Nonresidents’ short-term capital inflow to Israel is affected among other things by changes in interest rates in other advanced and emerging economies (not only the US and Europe) to which international capital flows are directed. In this context Israel’s interest rate may be compared to that in other countries (Table 3): the Bank of Israel’s interest rate is slightly below the interest rates of central banks in some advanced economies (Australia, 5.25 percent and New Zealand, 5 percent), only 0.75 percentage points higher than in the UK, and in the mid-range of central-bank interest rates in emerging markets and other developing economies. Moreover, the differential between interest on tradable government bonds such as in the US and Israel has contracted more rapidly than that derived from central banks’ interest rates.

 

The Bank of Israel monitors developments in the markets and will continue to act to bring the inflation rate into the price stability range while bolstering financial stability. Subject to these conditions, the Bank will continue to act to support the policy of fostering employment and boosting economic activity.

 

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 ratea

 

 

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

2003

–0.4

5.2

 

1.00

4.20

3.0

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

1.00

5.50

4.0

October

–0.4

6.1

1.00

5.10

3.6

November

–0.5

5.6

1.00

4.60

3.3

December

–0.4

5.2

1.00

4.20

3.0

200 4 January

–0.4

4.8

1.00
d

3.80

3.1

February

–0.3

4.5

 

 

 

 


a The rate of interest set in the previous month’s monetary program for the month indicated in the table.


b The risk premium, as measured by the 5-year credit-default-swap (CDS) market remained 60 basis points in December.


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 January 2004 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 bondsd

Effectiveb

Realc

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

6.7

5.2

6.2

4.6

8.3

October

6.1

6.4

4.7

5.8

4.4

7.6

November

5.6

5.8

4.7

5.4

4.2

7.3

December

5.2

5.4

4.6

4.9

4.1

7.0

2004      January

4.8

5.0

4.1

4.7

4.0

6.9

February

4.5

 

 

 

 

 

* 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.

 

 

Table 3:    Central-Bank Interest Rates in Several Countries,  January 2004

 

Advanced countries

Interest rate (percent)

Japan

0.00

Switzerland

0.25

US

1.00

ECB

2.00

Denmark

2.15

Norway

2.25

Canada

2.50

Sweden

2.75

UK

3.75

New Zealand

5.00

Australia

5.25

 

 

Emerging markets

 

Thailand

1.25

Taiwan

1.38

Chile

1.75

Korea

3.75

Israel

4.50

Mexico

6.10

South Africa

8.00

Brazil

16.50

Turkey

26.00

 

 

Other developing countries

 

Czech Republic

2.00

Poland

5.25

Hungary

12.50

 

 

Table 4: Distribution of the change in the public’s asset portfolio by type and indexation basis (excluding earmarked bonds)

 

 

12 02–06. 03

06.03–12.03

12.02–12.03

 

Percent of total nominal change

Total

100.0

100.0

100.0

Shares in Israel

74.0

46.6

61.0

Indexed to or denominated in foreign currency (including shares abroad)

 

–10.6

 

18.0

 

3.0

Unindexed

22.5

37.6

29.7

of which: in banks

1.2

–19.1

–8.4

              in the capital market

21.3

56.7

38.1

CPI-indexed (excluding earmarked bonds)

14.1

–2.3

6.3

of which: in banks

–1.2

–5.7

–3.4

              in the capital market

15.3

3.5

9.7

The total change in the value of the public’s financial assets portfolio excluding earmarked bonds in 2003 amounted to about NIS 150 billion (about 14 percent of the value of the portfolio at the end of 2002).

This table shows the contribution of the main types of assets to the total change in the value of the public’s asset portfolio in the last year.