The Bank of Israel's Monetary Program for March 2004

23.02.04

The Bank of Israel’s Monetary Program for March 2004

The Bank of Israel today announced its monetary program for March 2004, according to which the interest rate will be reduced by 0.2 percentage points to 4.3 percent. This brings the cumulative reduction in the Bank of Israel’s interest rate since December 2002 to 4.8 percentage points.

This reduction in the interest rate is made possible—despite a certain rise in inflation expectations and in long-term interest rates—by the continued calm in the foreign currency, money and capital markets, the actual reduction in the Consumer Price Index in the last year, and the continued moderate level of activity in the economy which is slowly emerging from recession. Together with the process of reducing the interest rate and narrowing the interest-rate differential between Israel and other countries, the money supply rose by about 10 percent in the last year and the NIS depreciated by about 8 percent against the currency basket since the end of June 2003. The cuts in the Bank of Israel interest rate since the end of 2002 have lowered short-term real interest from 7.2 percent to 3.1 percent in that period, and therefore help to encourage growth and boost employment while maintaining price stability and financial stability.

One-year inflation expectations derived from the capital market rose in January and February, and are currently above the lower boundary of the target range. Expectations for the second year ahead also rose, and are currently in the upper part of the target range. Private forecasters’ predictions of 12-month inflation also rose slightly and are below the middle of the target range, and some of the models developed by the Bank of Israel still 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 slowly.

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 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 taxes on financial assets. Furthermore, despite the reduction in the interest-rate differential between Israel and the rest of the world, there has been a gradual adjustment of the shares of local-currency and foreign-currency assets, as the markets continued functioning properly; only in the last two months have there been indications of a certain rise in Israelis’ investment abroad.

In the last month the decline in yields on government bonds halted, and a small rise was evident, particularly in the yield on the longest unindexed bond, which rose to 7.3 percent from 7.0 percent at the end of 2003. This follows a marked fall in yields during 2003, against the background of the reassertion of fiscal control, the receipt of the loan guarantees from the US government and the reduction of Israel's country risk. Perseverance in reverting to a downward path for the budget deficit and government debt is essential for the maintenance of stability and the continued reduction in interest rates for all periods. In this context it should be noted that the downward trend in Treasury bill yields also stopped, and for the first time since mid-2002 the yield on 12-month Treasury bills is higher than the Bank of Israel rate of interest. Deviation from a downward sloping deficit path, against the background of the high government debt of 105 percent of GDP, is likely to cause a rise in nominal and real yields and to create obstacles along the route of economic recovery, the first signs of which have appeared recently.

The calm in the foreign currency market evident in the last two months continued, with the weakening of the NIS relative to the dollar and its faster 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 February, after the downward path evident since the first quarter of 2003. 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 lower than the interest rates of central banks in some advanced economies (Australia, 5.25 percent and New Zealand, 5 percent), only 0.3 percentage points higher than in the UK, and in the mid-range of central-bank interest rates in emerging markets and other developing economies.

The Bank of Israel monitors developments in the markets and will continue to act, as it has acted hitherto, to bring the inflation rate into the price stability range while bolstering financial stability. This policy, which has reduced the short-term real rate of interest, helps to foster employment and boost economic activity, which is the main objective of the economic policy.

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

 

5.2

 

1.00

4.20

3.0

Monthly data

           

2002 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

2004 January

–0.4

4.8

1.00

3.80

3.1

February

–0.3

4.5

 

1.00d

3.50

3.5

March

–0.2

4.3

       

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 16 March 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

3.8

4.7

4.0

7.0

February

4.5

4.7

3.1

4.8

4.1

7.3

March

4.3

         

* 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.

aAnnounced interest rate in simple annual terms (excluding compound interest).

bCalculated as the daily compound interest rate, based on the interbank rate (see explanation in BOI no. 2, p. 17).

cThe real rate of interest is the effective rate of interest less inflation expectations derived from the capital market.

dUp 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

Norway

2.00

Denmark

2.15

Canada

2.50

Sweden

2.50

UK

4.00

New Zealand

5.00

Australia

5.25

   

Emerging markets

 

Thailand

1.25

Taiwan

1.38

Chile

1.75

Korea

3.75

Israel

4.30

Mexico

5.00

South Africa

8.00

Brazil

16.50

Turkey

24.00

   

Other developing countries

 

Czech Republic

2.00

Poland

5.25

Hungary

12.50