The Bank of Israel's Monetary Program for February 2005

24.1.2005
 
The Bank of Israel’s Monetary Program for February 2005
 
The Bank of Israel today announced that in the context of its monetary program for February 2005 the interest rate will be reduced by 0.2 of a percentage point, to 3.5 percent. The decision to lower the interest rate is based on the combination of developments in the economy that still make it possible under the current circumstances to cut the interest rate, following the reductions made in the last two months, although leaving less and less room to maneuver. The Bank of Israel's policy of maintaining price stability at the lowest possible short-term interest rate, against the background of the economy's financial stability, supports the long term recovery of real activity.
The developments underlying the decision to cut the interest rate include assessments regarding continued price stability, the calm and stability in the financial markets, and developments in the labor market.
Assessments of expected inflation for one and two years ahead as reflected in capital-market data and in the assessments of private forecasters still come within the government's target of price stability, i.e., between 1 percent and 3 percent a year long term, but at this stage they are in the lower part of the range.
In the foreign currency market the exchange rate has remained relatively stable for some time, and bid-offer spreads remain low. Israel's country risk premiums, as reflected by the financial markets, have been at a low level for some time and recently Israel's rating outlook has improved too. In this context it is noteworthy that the contraction of the interest-rate differential between the NIS and the dollar has continued without so far being reflected by the exchange rate, which is affected mainly by the conduct of the dollar world wide. At the same time the volatility of the exchange rate on the domestic market is lower than that of the global markets. It is also worth noting that for quite a while the economy has benefited from relatively large long-term-capital inflow.
The yield on one-year Treasury bills is currently at a low level of about 4.2 percent after falling from its level in May 2004 of 5.2 percent. The yields on Treasury bills with different maturities, which have also shown a downward trend, indicate that despite the narrowing of the interest-rate differentials between the NIS and the dollar, the capital market expects short-term nominal rates of return to rise to some extent, but in the longer term. The downward trend in yields on government bonds also persists. Thus, the yield on unindexed 10-year government (Shahar) bonds went down from 7.9 percent in May 2004 to its current level of less than 7 percent, and in the same period the real yield on indexed 10-year government (Galil) bonds declined from 4.4 percent to below 4 percent. This continued decline in long-term yields is an indication of the public's confidence in the government's ability to continue to adhere to the long-term budget framework it set, following its success in doing so in 2004. In this context the great importance of the Knesset's approval of the 2005 budget along the lines confirmed by the government must be stressed yet again; this would remove the remaining uncertainty in this area.
There has been steady improvement in the unemployment rate, but it is still relatively high. Thus, in the light of the continued improvement in labor productivity, the business-sector wage is not expected to exert inflationary pressure. The backdrop to this is the continued recovery in real activity, which also does not threaten upward pressure on prices in the near future.
 
Table 1: Interest Rates in Israel and the US
(Percent)
  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 5.5 5.7 –3.05
2000 –3.0 8.2 1.0 6.5 1.7 –4.0
2001 –2.4 5.8 –4.75 1.75 4.05 1.6
2002 3.3 9.1 –0.5 1.25 7.85 6.8
2003 –3.9 5.2 –0.25 1.0 4.2 3.0
Monthly data            
2004 January –0.4 4.8 0.0 1.0 3.8 3.1
February –0.3 4.5 0.0 1.0 3.5 3.5
March –0.2 4.3 0.0 1.0 3.3 3.8
April –0.2 4.1 0.0 1.0 3.1 3.6
May 0.0 4.1 0.0 1.0 3.1 3.2
June 0.0 4.1 0.0 1.0 3.1 3.0
July 0.0 4.1 0.25 1.25 2.85 3.2
August 0.0 4.1 0.25 1.5 2.6 3.7
September 0.0 4.1 0.25 1.75 2.35 3.8
October 0.0 4.1 0.0 1.75 2.35 3.4
November 0.0 4.1 0.25 2.0 2.1 3.2
December –0.2 3.9 0.25 2.25 1.65 2.7
2005 January –0.2 3.7 0.0 2.25 1.45 2.6
February –0.2 3.5 0.0d 2.25d 1.25d  
 
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 went up to about 43 basis points from about 41 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 February 2nd 2005 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 bonds
Headline rate (simple)a Effectiveb Realc
2002 December 9.1 9.6 7.2 7.9 5.7 10.9
2003 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 2.3 4.7 4.2 7.7
October 4.1 4.3 2.2 4.8 4.2 7.6
November 4.1 4.3 2.3 4.7 4.2 7.4
December 3.9 4.1 3.1 4.3 4.1 7.2
2005 January 3.7 3.9 3.0 4.2 4.0 7.0
February 3.5          
 
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, January 2005
(Percent)
Advanced countries Interest rate (percent)
Japan 0.00
Switzerland 0.75
US 2.25
Norway 1.75
ECB 2.00
Canada 2.50
Sweden 2.00
Denmark 2.15
UK 4.75
Australia 5.25
New Zealand 6.25
Emerging markets
Thailand 2.00
Taiwan 1.75
Chile 2.50
Korea 3.25
Israel1 3.50
Mexico 8.50
South Africa 7.50
Brazil 18.25
Turkey 17.00
Other developing countries
Czech Republic 2.50
Poland 6.50
Hungary 9.50
 
1 Israel's interest rate relates to February 2005