The Bank of Israel's Monetary Program for May 2004

25.04.04

The Bank of Israel’s Monetary Program for May 2004

The Bank of Israel today announced its monetary program for May 2004, according to which the interest rate will be unchanged at 4.1 percent, following its 5-percentage-point cumulative reduction that started at the end of 2002.

This pause in the process of lowering the interest rate, against the background of a certain rise in inflation expectations for one year forward and in private forecasters assessments, results from the development of certain parameters since the beginning of the year that create upward pressure on prices.

First, the NIS has depreciated by a cumulative 4 percent against the dollar since the beginning of the year, and by 2.5 percent against the currency basket.

Second, the rise in the money supply has accelerated, with a rise of 8 percent in the first four months of 2004 compared with a rise in the last twelve months of 14 percent.

Third, the rise in the money supply should be viewed against the background of the fact that since the beginning of the year the downward trend in yields on one-year Treasury bills and on government bonds has halted, and even reversed, and these have risen by 0.7 percentage points despite the reduction in the Bank of Israel interest rate.

Fourth, since the middle of 2003 the nominal and real wage per employee post have risen by more in the public sector than in the private sector, in contrast to their downward trend in 2002 and the first half of 2003.

Fifth, estimates of business-sector growth have been revised upwards, and now stand at 5 percent for 2004, compared with the modest rise of less than 2 percent in 2003.

Since the beginning of the year the differential between the yield on government bonds and the Bank of Israel interest rate has expanded markedly, which is inconsistent in the long run with price stability. Thus the differential between the yield on unindexed 10-year Shahar bonds and the Bank of Israel interest rate reached 3.3 percentage points in April 2004, up from only 2.0 percentage points in January 2004. This took place against the background of the rise in the yield on Shahar bonds from 7.0 percent in January 2004 to 7.6 percent in April 2004, a period when the Bank of Israels interest rate was declining. The differential between the yield on CPI-indexed ten-year Galil government bonds and the Bank of Israel real interest rate also rose to 1.4 percentage points in April 2004 from 0.2 percentage points in January 2004. This differential too widened due to the rise of the real yield on the Galil bonds, on the one hand, and the fall in the Bank of Israel implicit real interest to 2.9 percent, on the other (see Table A below)

The possibility of renewing the process of reducing the interest rate in the next few months will be affected by the following developments, and will depend on the inflation path remaining consistent with the price-stability target and on calm in the financial markets:

 

¦

A rise in capital inflow into the economy larger than capital outflow, which could occur with the increase in business-sector activity, is likely to cause the strengthening of the NIS, and reduce pressures for price rises;

¦

A fiscal policy that focuses on reducing the high debt burden, 105 percent of GDP in 2003, is likely to cause the renewal of the downward trend in yields on the domestic market, in contrast to the trend in the first four months of 2004, and this will probably enable the short-term interest rate to be reduced.

 

The Bank of Israel will continue the review its interest-rate policy month by month in the light of the above and other relevant developments, and will continue to strive towards the maintenance of price stability within the framework of the governments inflation target. In so doing it will contribute to the creation of the conditions required to support the turnaround in economic activity and the achievement of sustainable growth.

The Bank of Israel\'s interest rate continues to be lower than that of the central banks of some advanced economies (Australia and New Zealand), and similar to that of the Bank of England and to the average interest rate of the advanced and emerging countries.

Table A: The Widening Differential between the Bank of Israel Interest Rate and the Yield on Ten-Year Government Bonds

(percent)

Nominal interest rate

January 20004

April 2004a

Bank of Israelb

5.0

4.3

Shahar bonds

7.0

7.6

Differential (percentage points)

2.0

3.3

Real interest

 

 

Bank of Israelc

3.8

2.9

Galil bonds

4.0

4.3

Differential (percentage points)

0.2

1.4

 

a

Until 22 April.

b

Effective interest.

c

Bank of Israel effective interest rate minus 12-month inflation expectations

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

3.8

April

-0.2

4.1

 

1.00

3.10

3.6

May

0.0

4.1

 

1.00d

 

 

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

4.7

4.2

7.4

April

4.1

4.3

2.9

4.7

4.3

7.6

May

 

 

 

 

 

 

 

*

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

0.30

US

1.00

ECB

2.00

Denmark

2.20

Norway

1.75

Canada

2.00

Sweden

2.00

UK

4.00

New Zealand

5.30

Australia

5.25

 

 

Emerging markets

 

Thailand

1.30

Taiwan

1.40

Chile

1.75

Korea

3.80

Israel

4.10

Mexico

6.20

South Africa

8.00

Brazil

16.00

Turkey

22.00

 

 

Other developing countries

 

Czech Republic

2.00

Poland

5.30

Hungary

12.00