The Bank of Israel's Monetary Program for October 2004

27.09.04

The Bank of Israel’s Monetary Program for October 2004

The Bank of Israel today announced that in the context of its monetary program for October 2004, the interest rate will be unchanged at 4.1 percent, for the sixth month in succession.

The decision to leave the interest rate unchanged is based on the fact that assessments of inflation one and two years forward according to inflation expectations derived from the capital market and the predictions of private forecasters has been within the price-stability target range, i.e., 1-3 percent a year, for a considerable period. The background to the decision is ongoing stability in the financial markets, the expectation that the fiscal strategy being pursued in 2004 will continue following the confirmation of the 2005 budget by the government and the recovery in real activity.

Developments in the financial markets in the last six months are consistent with the stabilization of the Bank of Israel interest rate at 4.1 percent in that period, following its steady reduction month by month from the end of 2002 to April 2004 by a cumulative 5 percentage points.

Thus, stability in the foreign-currency market persisted during the last six months, with the exchange rate continuing to move without wide fluctuations and with no discernible trend, and with low bid-offer spreads. This took place against the backdrop of the continued narrowing of the interest-rate differential, both actual and expected, especially that between the NIS and the dollar. In the government bond and Treasury bill markets too calm has prevailed during the last half year. Nominal yields on government bonds (of the Shahar type) and on CPI-indexed bonds (of the Galil type) are stable, after following an upward trend during the first four months of the year. In the Treasury bill market the three-month yield has been maintained at close to the Bank of Israel interest rate, while the one-year yield declined by about half a percentage point in the last six months. Yields on the Treasury bill market thus reflect expectations of investors as well as of private forecasters that the interest rate will remain stable for some time and will then rise.

 

According to Bank of Israel assessments the performance of the 2004 budget continues to be consistent with the budgetary targets set. At this stage it is important that the Knesset approve the proposed 2005 budget decided upon by the government. This budget expresses a fiscal strategy based on budget targets up to the end of the decade, according to which the deficit will not exceed 3 percent of GDP, and government expenditure will not rise by more than one percent a year in real terms a policy that will lead to the reduction of the government debt burden and of the cost of servicing the debt. This is the foundation required for the reduction of long-term interest and for the return of the economy onto a path of sustained growth, led by the business sector.

The recovery in real activity is continuing, with a decline in the share of government expenditure in GDP and a considerable rise in business-sector product. At the same time the number of employees has risen, as have the rate of employment and the rates of participation in the labor market which have halted the upward trend in the rate of unemployment. Concurrently the balance of payments has come close to being in balance.

It is essential that the government persist in important structural reforms in the ports, the financial markets, the labor market, and the public services such as in the local authorities. These steps, together with the continuation of the macroeconomic policy, monetary and fiscal, and with vigorous management of infrastructure investment, will release resources for private-sector activity and will help to cause a positive turnaround in investment in the principal industries, and thereby ensure the conditions for sustained growth.

The process of lowering the interest rate until its convergence to its current level in the last half year is reflected among other things by a low level of real interest, in particular short term, and by a rise in the money supply. This interest-rate policy provides important support for the continued recovery of real activity based on financial stability in general and price stability in particular.

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

-2.3

11.2

0.75

5.50

5.70

-3.05

2000

-3.0

8.2

1.00

6.50

1.70

-4.0

2001

-2.4

5.8

-4.75

1.75

4.05

1.6

2002

3.3

9.1

-0.50

1.25

7.85

6.8

2003

-3.9

5.2

-0.25

1.00

4.20

3.0

Monthly data

 

 

 

 

 

 

2002 December

0.0

9.1

0.0

1.25

7.85

6.8

2003 January

-0.2

8.9

0.0

1.25

7.65

7.5

February

0.0

8.9

0.0

1.25

7.65

7.9

March

0.0

8.9

0.0

1.25

7.65

7.0

April

-0.2

8.7

0.0

1.25

7.45

5.6

May

-0.3

8.4

0.0

1.25

7.15

5.0

June

-0.4

8.0

0.0

1.25

6.75

4.7

July

-0.4

7.5

-0.25

1.00

6.50

4.1

August

-0.5

7.0

0.0

1.00

6.00

4.3

September

-0.5

6.5

0.0

1.00

5.50

4.0

October

-0.4

6.1

0.0

1.00

5.10

3.6

November

-0.5

5.6

0.0

1.00

4.60

3.3

December

-0.4

5.2

0.0

1.00

4.20

3.0

2004 January

-0.4

4.8

0.0

1.00

3.80

3.1

February

-0.3

4.5

0.0

1.00

3.50

3.5

March

-0.2

4.3

0.0

1.00

3.30

3.8

April

-0.2

4.1

0.0

1.00

3.10

3.6

May

0.0

4.1

0.0

1.00

3.10

3.2

June

0.0

4.1

0.0

1.00

3.10

3.0

July

0.0

4.1

0.25

1.25

2.85

3.2

August

0.0

4.1

0.25

1.50

2.6

3.7

September

0.0

4.1

0.25

1.75 d

 

 

October

0.0

4.1

 

 

 

 

 

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 similar to its level a month earlier, at about 58 basis points.

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 10 November 2004 for its regular review of interest-rate policy.

 

Table 2: The Bank of Israel Real Rate of Interest, the Nominal Yield on Treasury Bills and on Unindexed Government Bonds, and the Real Yield on CPI-Indexed Government Bonds

(monthly average, percent)

 

Bank of Israel rate of Interest

Yield on 12 month Treasury bills

Real yield on CPI- indexed 10- year bonds

Yield on unindexed 10- year bondsd

Headline rate (simple)a

Effectiveb

Realc

2002 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

4.9

4.1

7.4

March

4.3

4.5

3.3

4.9

4.2

7.4

April

4.1

4.3

2.7

4.8

4.3

7.6

May

4.1

4.3

2.3

5.2

4.4

7.9

June

4.1

4.3

2.5

5.0

4.3

7.8

July

4.1

4.3

2.8

4.8

4.3

7.8

August

4.1

4.3

2.4

4.8

4.3

7.9

September

4.1

4.3

2.4

4.7

4.3

7.8

October

4.1

 

 

 

 

 

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.

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

Advanced countries

Interest rate (percent)

Japan

0.00

Switzerland

0.75

US

1.75

ECB

2.00

Denmark

2.15

Norway

1.75

Canada

2.25

Sweden

2.00

UK

4.75

New Zealand

6.25

Australia

5.25

Emerging Markets

 

Thailand

1.50

Taiwan

1.375

Chile

2.00

Korea

3.50

Israel

4.10

Mexico

7.20

South Africa

7.50

Brazil

16.25

Turkey

20.00

Other developing countries

 

Czech Republic

2.50

Poland

6.50

Hungary

11.50