The Bank of Israel interest rate for June 2007 cut by 25 basis points to 3.5 percent

28.5.2007
 
The Bank of Israel interest rate for June 2007 cut by 25 basis points to 3.5 percent
 
The Bank of Israel announces that the interest rate for June 2007 will be cut by 25 basis points, to 3.5 percent. This step is consistent with the Bank of Israel's policy of aiming for the inflation target of 1–3 percent a year.
Background conditions
Inflation data: In line with earlier forecasts, the Consumer Price Index (CPI) rose by 0.5 percent in April. In the last twelve months the CPI has fallen by 1.3 percent, so that the rate of inflation over that period was below the lower boundary of the target range of 1 percent. In contrast, the domestic component of prices, as calculated by econometric models, rose by more than 2 percent. This discrepancy between changes in the CPI and local prices is mostly explained by the appreciation of the shekel against the dollar.
Forecasts: The average prediction of inflation for the next twelve months by Israeli forecasters stands at 1.2 percent. At the same time, most private forecasters expect a cut of 25 basis points in the interest rate for June. Their forecasts for the Bank of Israel interest rate at the end of 2007 range between 3.25 percent and
4 percent. The expectation of inflation over the next 12 months, as derived from the capital markets, is 0.5 percent, while the makam curve implies that the interest rate will decline by 0.3 percentage points during the next year. According to the econometric models, assuming the exchange rate against the dollar remains at about its current level and that the Bank of Israel interest rate is cut by 25 basis points, inflation will return to within the target range in the first half of 2008.
Real economic activity: According to data of the CBS published yesterday, in the first quarter of the year, the expansion in economic activity continued. GDP grew by 6.3 percent (in annual terms), the unemployment rate dipped by 0.1 percentage points to 7.7 percent, and the rate of participation in the labor force rose by 0.5 percentage points to 56.1 percent. After four years of increases, the upward trend in labor productivity has come to a halt and as a result, unit labor costs appear to be rising.
Government activity: The government registered a surplus in its finances, mostly due to a rise in tax revenues. Government budget data are consistent with an annual deficit of between 1 percent and 1.5 percent of GDP.
Forex market: Since the previous interest rate decision (18/4/07), the shekel has strengthened against the dollar and the euro by 0.9 percent and 1.9 percent, respectively. Most of this appreciation of the shekel was due to domestic factors. Average daily trading volume on the forex market in May rose to $1.7 billion compared to $1.2 billion in the previous five quarters.
Capital market: Since the previous interest rate decision, share prices on the stock exchange rose by 5 percent, further to a rapid increase of about 14 percent from the beginning of the year until mid-April. At the same time, yields on government bonds of all maturities fell by about 0.2 percentage points. For some of the period, the yield to maturity on 10-year local-currency government bond was lower than that on 10-year US government bonds. Israel's sovereign risk premium, as measured by the five-year CDS spread, remained at the low level of 0.17 percent.
Global background conditions: Strong global growth is expected to continue in the coming year albeit at a more moderate pace; global inflation remains relatively moderate and is expected to continue falling. Capital markets expect that the US Fed funds rate will be cut by 25 basis points by the end of the year. The markets expect the European and Japanese central banks to continue raising interest rates.
The main considerations behind the decision
  In the framework of the Bank of Israel's commitment to the government-set inflation target of 1-3 percent, a reduction in the interest rate is required to raise the probability of returning inflation to within the target range in the first months of 2008.
  Despite the rise in domestic prices as derived from econometric models and the economic expansion of recent years, there still appear to be no inflationary pressures, whether in inflation expectations or in actual inflation figures.
  The reduction of 25 basis points in the interest rate is based, inter alia, on the need to continue to contribute to the preservation of financial stability. In this framework, the Bank of Israel will continue to monitor developments in, and the functioning of, the financial markets.
The Bank of Israel will continue to monitor economic developments closely with the intention of achieving the price-stability target. Subject to this, the Bank will continue to support the attainment of a range of objectives of macroeconomic policy, in particular the encouragement of employment and growth. In addition, the Bank will continue to support the stability of the financial system.
   
Please note:
The minutes of the discussions prior to the above interest rate decision will be published on 11 June 2007.
The decision regarding the interest rate for July will be published at 18:30 on 25 June 2007.