The Bank of Israel's Monetary Program for April 2004

29.03.04

The Bank of Israel’s Monetary Program for April 2004

The Bank of Israel today announced its monetary program for April 2004, according to which the interest rate will be reduced by 0.2 percentage points to 4.1 percent. This brings the cumulative reduction in the Bank of Israels interest rate since December 2002 to 5 percentage points.

This reduction in the interest rate is consistent with the need to bring inflation into the price-stability range of 1 to 3 percent a year and to stabilize it there. Inflation expectations, as derived from the bond yields on the capital market, are still in the area of the lower limit of the target, at around 1.2 percent. Private forecasters predictions of 12-month inflation reached about 1.8 percent. These developments regarding the inflation rate are also supported by the slow weakening of the NIS against the dollar, and its faster depreciation against the currency basket, in the first quarter of the year. Concurrently, there was continued stability in the financial markets in general and in the foreign-currency market in particular.

Assessments of the development of fiscal policy over the year suggest that the budget target set by the government at 4 percent of GDP is attainable. These assessments are also reflected by the financial markets, and especially by the changes in the yields on bonds issued by the government to finance the deficit.

Together with continued financial stability, the resilience of the economy is also recognized by the international capital markets. The financial risk of Israel\'s economyas viewed by Israeli and foreign investors, as expressed in the latest publications by international financial companies and as measured by the 5-year credit-default-swap (CDS) marketcontinues to decline and reached a low level.

Another sign of the economys stability, in particular as it is an economy open to capital flows, is the publics gradual adjustment of its financial assets portfolio, against the background of the lowering of the interest rate, the reform of income tax on individuals, and the completion of the foreign exchange liberalization process. This adjustment reflects the publics desire to spread its investments between local and foreign assets, and between bank deposits and capital-market investments, and thereby to reduce the risks of these investments and even improve their rates of return.

The Bank of Israel continues to monitor with a very watchful eye the spread that has widened in the last three months between long-term and short-term yields on the domestic capital market. Thus, for example, the yield spread between three-month Treasury bills and 10-year Shahar bonds that stood at 2.1 percentage points in December 2003, reached 3.1 percentage points in March 2004. The persistent widening of this spread, at a time when the money supply is rising, is inconsistent with price-stability in the long run.

The persistent lowering of the interest rate since the end of 2002 helps bring about sustainable growth while maintaining price and financial stability. In this context is should be emphasized that the reduction of the Bank of Israel interest rate, combined with the rise in expected inflation to within the price-stability target, creates a process of reducing short-term real interest. This interest went down from 7.2 percent in December 2002 to 4.6 percent in December 2003, and continued declining to reach 3.3 percent in March 2004. Thus the interest-rate policy contributes to the achievement of the central objective of economic policy.

The Bank of Israels interest rate continues to be lower than the interest rates in several advanced economies (Australia, and New Zealand), and similar to the rate in the UK. It is also similar to the average rate of central banks in emerging markets and other developing economies. This comparison with the interest rates of a wide range of countries is important because short-term capital flows into and out of the economy (by domestic and foreign investors) are affected by changes in interest rates in the various emerging markets and developing economies.

The Bank of Israel\'s current interest-rate policy will continue as long as the inflation path is consistent with the governments price-stability target and the financial markets continue to exhibit stability and financial resilience.

Table 1: Interest Rates in Israel and the US

 

 

Central banks interest rates

Yield spread between US and Israel 10-year govt. bondsc

 

Israel

US

Differential between central banks interest ratesb

 

 

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

 

1.00

3.50

3.5

March

-0.2

4.3

 

1.00

3.30

3.5

April

-0.2

4.1

 

1.00d

3.1

 

 

a

The rate of interest set in the previous months 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, similar to its level a month earlier.

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 4 May 2004 for its regular review of interest-rate policy.

 

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

3.2

4.8

4.1

7.4

March

4.3

4.5

3.3

4.8

4.2

7.3

April

4.1

 

 

 

 

 

 

*

Including two increases in the interest rate in the month. The Bank of Israels 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, March 2004

 

Advanced countries

Interest rate (percent)

Japan

0.00

Switzerland

0.25

US

1.00

ECB

2.00

Denmark

2.15

Norway

1.75

Canada

2.25

Sweden

2.50

UK

4.00

New Zealand

5.25

Australia

5.25

 

 

Emerging markets

 

Thailand

1.25

Taiwan

1.38

Chile

1.75

Korea

3.75

Israel

4.10

Mexico

5.60

South Africa

8.00

Brazil

16.25

Turkey

22.00

 

 

Other developing countries

 

Czech Republic

2.00

Poland

5.25

Hungary

12.50