The Bank of Israel leaves the interest rate for June 2006 unchanged at 5.25 percent

29.5.2006
 
The Bank of Israel leaves the interest rate for June 2006 unchanged at 5.25 percent
 
The interest rate for June 2006 will remain unchanged at 5.25 percent. The decision to leave the interest rate unchanged is consistent with the achievement of price stability within the limits of the target of between 1 percent and 3 percent inflation a year as determined by the government.
Background conditions
National Accounts data for the first quarter of the year indicated rapid growth in the economy, faster than expected. The monthly indicators continue to point to further and firmer growth. Growth is accompanied by an improvement in the labor market: unemployment rate in the first quarter fell to 8.7 percent and the number of employees in the business sector continued to rise. The recovery in the labor market is accompanied by wage rises, although labor productivity has also increased such that average unit labor costs have remained unchanged.
The CPI in the past 12 months increased by 3.8 percent, above the upper limit of the inflation target. However in the coming months, 12-month inflation is expected to converge to within the target range. Inflation expectations for the next 12 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 Bank of Israel will raise the interest rate by about 50 basis points by the end of the year.
Throughout April and in the first half of May, the NIS appreciated sharply––by 5 percent against the dollar and by 2.8 percent against the currency basket. The strengthening of the NIS was due to a combination of global factors––that is the weakening of the dollar globally––and local factors connected, inter alia, to the new government's commitment to maintaining the budgetary policy, the positive developments of the Israeli economy and the positive evaluations of foreign investment houses including the expected raising of Israel's credit rating.
From May 9, a trend began of sharp drops on the stock markets in the emerging economies, accompanied by the depreciation of their currencies against the dollar. Morgan Stanley's Emerging Markets Share Index fell by 15 percent. The NIS in this period depreciated against the dollar by only 1.5 percent.
According to the budget figures and the government's declared statements, it is expected that the new government will continue with a responsible fiscal policy. The rapid increase in real economic activity brought an increase in tax revenues, while government expenditure in the period January to April was low, reflecting the absence of an approved budget: Until the 2006 budget is approved, government expenditure will continue to be governed by the law on the absence of an approved budget, in which monthly expenditure is limited to one-twelfth of the previous year's budget.
The main considerations behind the decision
In examining all major factors that are expected to affect future price development, a number of opposing forces were found:
On the one hand, rapid growth and improved employment point to possible inflationary pressures during the coming year. These pressures could also continue to push up nominal wages in the economy.
On the other hand, several factors act to moderate the inflationary pressures:
  The strengthening of the NIS at a cumulative rate of 3.5 percent since the beginning of April moderates the forces pushing prices up.
  Maintaining budgetary discipline and reducing national debt as a percentage of GDP will support growth while holding back the mounting demand pressures in the economy.
An examination of all the factors led to the decision to leave the interest rate unchanged this month. This was taken in the light of expectations that inflation will converge to within the target range in the coming months and to the midpoint of the range in 12 months' time. This expectation is based on estimates by the capital market and forecasts that the Bank of Israel will raise the interest rate by some 50 basis points by the end of the year.
The Bank of Israel will continue to monitor economic developments closely with the intention of achieving the government's price-stability target. Subject to this, the Bank will continue to support the attainment of a range of objectives of macroeconomic policy, particularly with respect to increasing employment and growth. In addition, the Bank will continue to support financial stability.