The Bank of Israel raises the interest rate for April 2006 by 25 basis points to 5 percent

27.3.2006
 
The Bank of Israel raises the interest rate for April 2006 by 25 basis points to 5 percent
 
The interest rate for April 2006 will rise by 25 basis points to 5 percent. The decision to raise the interest rate is intended to help maintain price stability within the limits of the target of between one percent and three percent inflation a year determined by the government
Background conditions
The most recent economic data indicate relatively rapid growth in Israel. Thus, the composite state-of-the-economy index rose by 0.3 percent in February. Against the background of continued relatively rapid growth in the global economy and the expectation that the government's macroeconomic strategy will continue, growth is expected to be sustained.
In February the CPI rose faster than anticipated (by 0.6 percent). The main surprise occurred in prices of non-seasonal foods. The actual price rise (in the previous twelve months) was 3.1 percent, slightly above the upper limit of the inflation target. Inflation expectations for the next twelve months, derived from the capital market and economists' forecasts, are that inflation will be close to the midpoint of the target range, under the assumption that the interest rate will continue to rise.
The financial markets remained stable. Yields to all terms rose by 10 basis points from the beginning of March, and the exchange rate of the NIS hardly changed. Share prices went up in March, and the Tel Aviv 100 Index rose by 4.4 percent.
In the major economies, the gradual process of rising interest rates continued. The European Central Bank increased its interest rate in March by 25 basis points, and the interest rate in the US is expected to continue rising moderately.
Until the formation of a new government, budgetary policy will be governed by the law that in the absence of an approved budget, monthly expenditure is limited to one-twelfth of the previous year's budget. This ensures that budgetary policy will remain restrained during the period until the approval of a new budget. The Bank of Israel expects that the new government will continue to follow the responsible fiscal policy pursued in the last few years.
During the last month there was no significant change in the level of geopolitical uncertainty.
The main considerations that led to the decision
Against this background, the Bank of Israel focused on the main factors that could affect the inflation environment in the coming twelve months:
  Increases in demand and the gradual contraction of the output gap;
  Developments in interest rates abroad and the interest-rate differential between the United States and Israel.
Increases in demand in Israel and the process of utilizing the surplus production capacity continue to narrow the gap between potential and actual GDP (the output gap). This holds the potential for increasing the rate of inflation and accelerating the rise of nominal wages. There are several methods of measuring the output gap, but whichever method is used it is clear that the gap is narrowing. The increase in the rate of inflation over the previous twelve months from a level slightly below the price-stability range a year ago to a level slightly above it in February 2006 reflects at least in part the effect of the contraction of the output gap.
Interest rates in the major world markets are expected to continue rising moderately. The Bank of Israel considers the interest-rate differential vis-?-vis abroad to be one of the important factors affecting the exchange rate and hence inflationary pressures. This is a factor that contributes to the decision to raise the interest rate for April. However, the Bank of Israel does not consider that a constant interest-rate differential vis-?-vis abroad is necessary in order to achieve the inflation target, but that the appropriate differential is affected by global and domestic economic developments.
The Bank of Israel will continue to monitor economic developments closely, with the intention of achieving the government's price-stability target. In addition, the Bank will continue to support the attainment of the range of objectives of macroeconomic policy, particularly with respect to increasing employment, maintaining growth and bolstering financial stability.