The Bank of Israel's interest rate for March 2006 remains unchanged at 4.75 percent

20.2.2006
 
The Bank of Israel’s interest rate for March 2006 remains unchanged at 4.75 percent
 
The interest rate for March 2006 remains unchanged at 4.75 percent. The decision to leave the rate at its current level is consistent with the maintenance of price stability within the limits of the target determined by the government of between one percent and three percent inflation a year.
Background conditions
The most recent economic data indicate continued relatively rapid growth in Israel, in line with the Bank of Israel's expectation of growth of 4.3 percent for 2006. Most recent indications point to a continuation of relatively rapid growth also in the world economy. Global interest rates have continued to rise, as expected.
In the month since the last interest-rate decision, the Palestinian elections were held, the stock market declined by about 6 percent, and the NIS depreciated by about 2 percent against the US$. In January the CPI dipped by 0.3 percent, in the upper part of the range of forecasts. Market expectations of inflation for the next twelve months have risen and are now slightly above 2 percent, a level similar to that of most forecasters, but well within the target range of 1-3 percent.
In considering its interest-rate decision, the Bank of Israel focuses on the likely behavior of inflation over the next twelve months, taking into account also the pace of expansion of real activity, both of which factors are affected by global and domestic economic conditions. The global economy is well-poised to continue to grow at a good pace, and global inflation appears to be tending downwards, leading market participants to expect the lengthy phase of United States interest-rate tightening to draw to a close relatively soon. Energy prices appear to be moderating, but remain vulnerable to supply disruptions.
Inflationary pressures in Israel in 2005 came primarily from the combined effects of the depreciation of the currency and higher import prices, that is, from external sources. Although rapid growth is closing the output gap, it is likely that significant excess capacity remains in the economy. The rise in the nominal wage has been restrained, relative to the increase in productivity.
Until the next government is formed, fiscal policy will continue to be determined by the law that specifies that, in the absence of an approved budget, one-twelfth of the previous year's budget will be implemented each month. This ensures that fiscal policy will remain restrained until the approval of a new budget, after the election. The Bank of Israel expects that after the election the new government will continue pursuing the responsible fiscal policy of recent years. That policy is essential for the continued gradual reduction of Israel's debt/GDP ratio.
The main considerations that led to the decision
Against this background, including the continuing growth of the economy, the Bank of Israel's discussions focused on several factors that could affect inflation in the coming twelve months:
  Foreign interest rates and the interest-rate gap between the United States and Israel;
  The likely behavior of the exchange rate; and
  Geopolitical uncertainties.
While interest rates in both the United States and Europe are likely to rise in March, the Bank of Israel does not believe that an increase in the interest-rate gap with the United States is needed at the present juncture to keep inflation within the target range. The Bank views the interest rate gap with abroad as an important determinant of the likely behavior of the exchange rate and consequent inflationary pressures, but does not believe that there is a unique level of the gap that is needed to maintain inflation within the target range set by the government. The interest-rate gap needed to achieve the government's inflation target is affected by developments in both the global and domestic economies. That said, expectations of increased interest rates abroad and the continued narrowing of Israel's output gap increase the probability that interest rates in Israel will rise somewhat during the remainder of the year.
The recent depreciation of the NIS may have a small inflationary impact, but in light of the strong underlying trends in capital movements into Israel, that impact is unlikely to persist over the course of the year. The Bank of Israel will act as necessary to achieve the government's inflation target.
Finally, geopolitical uncertainties have increased recently. The most recent increases in the Bank of Israel interest rate were implemented in part in light of these uncertainties, and the Bank sees no need for a further increase at this time.
The Bank of Israel will continue to monitor economic developments closely, with the intention of achieving the government's price-stability target. The Bank will continue to support the attainment of the range of objectives of macroeconomic policy, particularly with respect to increasing employment and maintaining growth and financial stability.