The Governor of the Bank of Israel: The Bank of Israel's interest rate policy, together with the Ministry of Finance's budget policy, led to important economic achievements in 2006 ? rapid growth, financial stability and low inflation

10.1.2007
 
The Governor of the Bank of Israel: The Bank of Israel's interest rate policy, together with the Ministry of Finance's budget policy, led to important economic achievements in 2006 – rapid growth, financial stability and low inflation
The Bank of Israel's interest rate policy is expected to bring inflation
back to within its target range during 2007
 
The Israeli economy demonstrated impressive achievements in 2006––rapid growth, financial stability and low inflation––despite external events such as the hostilities in the north. The Bank of Israel's interest rate policy succeeded in supporting economic stability while maintaining low inflation. However inflation for 2006, based on estimates of the consumer price index for December and the cumulative CPI since January 2006, is expected to be close to zero, below the inflation target of 1–3 percent. The Bank of Israel expects to continue its measured interest rate policy and to bring inflation gradually back to within the target range during 2007, while avoiding unnecessary fluctuations in the financial markets.
In the first half of 2006, inflation over the previous 12 months was higher than the target range (that is above 3 percent), principally due to the effects of rising energy prices worldwide. At the time, the Bank of Israel continued its flexible approach regarding its monetary policy, with the aim of bringing inflation back to within its target range within the year. The Bank of Israel expected to achieve this around mid-2006, as indeed happened. The second half of the year saw particularly low levels of CPI inflation, mainly against the background of the effects of a shekel appreciating vis-?-vis the dollar, as well as developments in the global and Israeli economies. These developments reflect the strength of the Israeli economy: an impressive current account surplus in the balance of payments, and inward foreign investment.
These were the words of the Governor of the Bank of Israel, Professor Stanley Fischer, in a press conference today in which he presented a summary of the Bank of Israel's interest rate policy for 2006 and the Bank's assessments for 2007.
In summing up 2006, the Governor said that the Bank of Israel believes that the ability of the economy to continue growing in 2006, despite the political changes and the fighting in the north in the summer, while maintaining financial stability and price stability, are a credit to the policy makers––the Ministry of Finance and the Bank of Israel––as well as the business sector, which continued to function and develop even during the time of hostilities in the north. During the war, the Bank of Israel raised the interest rate in order to signal to the local and global markets its determination to maintain price and financial stability. This policy, against a background of the Ministry of Finance's disciplined budget policy, allowed the interest rate to be cut cumulatively in recent months leading to a significant negative gap between the Bank of Israel's interest rate and that of the US Federal Reserve, the Governor pointed out.
Inflation is expected to return to within its target range by Q4 2007
In 2007, the Bank of Israel will continue its policy of attempting to return inflation gradually to within the target range. Just as too sharp a rise in the interest rate was not required in the first half of 2006, when inflation was higher than the target range, so now a policy of cutting the interest rate too aggressively is similarly uncalled for. Such sharp changes in the interest rate could cause excessive fluctuations in inflation and output. The Bank of Israel will therefore continue to adjust the interest rate when required, according to the its analysis of developments prior to its monthly decision. By the Bank's assessments, inflation over the past 12 months is expected to return to within the target range by the fourth quarter of 2007. The Bank's monetary policy up to now, and particularly the cumulative interest rate reduction of a full percentage point in recent months, as well as the monetary policy for 2007, will act to strengthen the probability that this will be the outcome for inflation.
It is also important to note that unexpected events could affect inflation during the year, for example, changes in the price of oil or fluctuations in the exchange rate, and that inflation during 2007 could accordingly differ from current assessments. Therefore, the Bank of Israel will continue to monitor economic developments, in order to manage monetary policy in a way that is consistent with achieving the price-stability target over a horizon of about a year.