The Bank of Israel's Monetary Program for December 2004

22.11.2004
 
The Bank of Israel's Interest Rate for December 2004
 
The Bank of Israel today announced that in the context of its monetary program for December 2004, the interest rate will be reduced by 0.2 of a percentage point, to 3.9 percent.
 
The decision to lower the interest rate is based on the Bank’s assessment that the cumulative economic developments in the last few months indicate that it may be possible to continue maintaining price stability at a lower interest rate than that prevailing hitherto. This is consistent with the Bank of Israel's policy of supporting the continued recovery in real activity at the lowest possible short-term interest rate by preserving price stability, thereby contributing to financial stability.
 
Several developments that occurred in the last few months, since the Bank of Israel's interest rate was first reduced to 4.1 percent, indicate that Israel's economy may currently be in a situation in which price stability can be maintained at a lower rate of interest:
 
Inflation: Although assessments of inflation twelve months forward—both inflation expectations derived from the capital market and predictions of private forecasters—have been at the center of the price-stability target for several months, the CPIs published in the last few months indicate monthly price rises close to zero. Furthermore, according to the forecasters this situation is expected to persist in the coming months. It thus seems that the picture that emerges within a one-year horizon is one in which although the forecast price increases are likely to take place, this will not be in the near future.
 
It should be noted with regard to prices that real activity continues to recover, but the current slower rate of recovery means weaker pressure on prices.
 
The changes in the public’s financial asset portfolio also shows that the public is not concerned about the possibility of continued price rises, and this is reflected by the persistent decline in the share of CPI-indexed assets, and by the absence of a tendency to increase the share of exchange-rate-indexed investments.
 
The foreign currency market: The assessment is becoming more firm that with the steady narrowing of the interest differential between the NIS and the dollar, which is expected to continue, in the present circumstances the economy can cope with smaller interest-rate differentials than in the past without causing a deviation from the path of price stability. Moreover, the narrowing of the interest-rate differentials has until now not been reflected by the behavior of the exchange rate, which is currently affected mainly by the worldwide weakness of the dollar. The various indicators derived from the financial markets point to the possibility that the contraction of the interest-rate differentials will eventually be expressed by a certain rise in the exchange rate, but not in the near future. In this context it is relevant to note that for some time the economy has benefited from long-term capital inflow of about $ 4-5 billion a year, and it appears that this is likely to continue in the future. The foreign currency market has been operating for a while at low bid-offer spreads, with low volatility, and at a relatively low volume of trade.
 
Fiscal policy: The slow persistent decline in yields in the Treasury-bill and government-bond markets shows that the financial markets continue to consider the long-term fiscal discipline adopted by the government—expressed by the budget targets for 2005 and thereafter—as credible. In this context it is essential for the Knesset to pass the 2005 budget, along the lines confirmed by the government, without delay, and thus remove the uncertainty that still lingers in this area.
 
The government must take special steps to boost economic growth. Heading the list is organizing priorities so that infrastructure investment moves up the scale. In this way the government would support investment in the economy in general, and in particular would help the construction industry, whose growth is still lagging behind that in other principal industries. In addition, the structural changes in the capital market recommended by the Bachar Committee and confirmed by the government must be implemented. This would ease the financing constraint of long-term investments and would complement the policy of speeding up the rate of infrastructure investment.
 
The Bank will continue to monitor closely world wide developments in exchange rates and capital flows into and out of Israel. These, together with the preservation of the credibility of fiscal discipline, could affect the Bank’s ability to keep short-term interest rates low to encourage growth while maintaining price stability.
 
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 5.7 -3.05
2000 -3.0 8.2 1 6.5 1.7 -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 4.2 3.0
Monthly data            
2002 December 0 9.1 0 1.25 7.85 6.8
2003 January -0.2 8.9 0 1.25 7.65 7.5
February 0 8.9 0 1.25 7.65 7.9
March 0 8.9 0 1.25 7.65 7.0
April -0.2 8.7 0 1.25 7.45 5.6
May -0.3 8.4 0 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 6.5 4.1
August -0.5 7 0 1 6 4.3
September -0.5 6.5 0 1 5.5 4.0
October -0.4 6.1 0 1 5.1 3.6
November -0.5 5.6 0 1 4.6 3.3
December -0.4 5.2 0 1 4.2 3.0
2004 January -0.4 4.8 0 1 3.8 3.1
February -0.3 4.5 0 1 3.5 3.5
March -0.2 4.3 0 1 3.3 3.8
April -0.2 4.1 0 1 3.1 3.6
May 0 4.1 0 1 3.1 3.2
June 0 4.1 0 1 3.1 3.0
July 0 4.1 .25 1.25 2.85 3.2
August 0 4.1 .25 1.5 2.6 3.7
September 0 4.1 .25 1.75 2.35 3.8
October 0 4.1 0 1.75 2.35 3.4
November 0 4.1 0.25 2.00 2.10 3.2
December -.2 3.9   2.00d 1.90d  
 
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 was
  about 41 basis points in November, compared to 45 basis points 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 14 December 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 8.5
June 8 8.4 6.8 7.1 4.6 8
July 7.5 7.9 5.4 6.7 4.4 8
August 7 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
2004 January 4.8 5 3.8 4.7 4 7
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 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 2.3 4.7 4.2 7.7
October 4.1 4.3 2.2 4.8 4.2 7.6
November 4.1 4.3 2.2 4.7 4.2 7.4
December 3.9          
 
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, October 2004
Israel's interest rate relates to December
Advanced countries Interest rate (percent)
Japan 0
Switzerland 0.75
US 2.00
ECB 2.00
Denmark 2.15
Norway 1.75
Canada 2.5
Sweden 2
UK 4.75
New Zealand 6.25
Australia 5.25
Emerging markets  
Thailand 1.75
Taiwan 1.625
Chile 2.25
Korea 3.25
Israel 3.9
Mexico 7.8
South Africa 7.5
Brazil 17.25
Turkey 20.00
Other developing countries  
Czech Republic 2.5
Poland 6.5
Hungary 10.5