The Bank of Israel interest rate remains unchanged for July 2007 at 3.5 percent

25.6.07
 
The Bank of Israel interest rate remains unchanged for July 2007 at 3.5 percent
 
The Bank of Israel announces that the interest rate for July 2007 will remain unchanged at 3.5 percent. This is consistent with the policy of maintaining price stability, as expressed by the inflation target of 1–3 percent a year.
Background conditions
Inflation data: The Consumer Price Index (CPI) remained unchanged in May, slightly above earlier forecasts. In the last twelve months the CPI has fallen by 1.3 percent, a rate of inflation significantly below the lower boundary of the target inflation range.
Forecasts: Israeli forecasters predict, on average, that inflation for the next twelve months will reach 2.3 percent. At the same time, they expect, on average, that the Bank of Israel interest rate will stand at 3.75 percent in a year's time. The expectation of inflation over the next 12 months, as derived from the capital markets, now stands at 2.1 percent, close to the midpoint of the target range. The market expects that the interest rate will rise by 0.25 percentage points over the same period.
Real economic activity: The expansion in economic activity continues, and GDP is expected to grow this year by 5.1 percent. The composite state-of-the-economy index rose in May by 0.7 percent. The closure of the output gap following continued economic expansion is still not reflected in a rise in unit labor costs, although unit labor costs, which have fallen for the past three years, are no longer declining.
Government activity: The continuing trend in increased government revenues is expected to bring the deficit this year to between 1 percent and 1.5 percent of GDP. However recent government decisions on the budget have increased the risks of raising the path of public expenditures.
Forex market: Since the previous interest rate decision (on May 27) up till June 25, the shekel weakened against the dollar and the euro by 5.4 percent and 5.7 percent, respectively. Despite this weakening of the shekel against the dollar, the underlying forces supporting the value of the shekel––the surplus in the current account of the balance of payments and foreign investment in the economy––continue.
Capital markets: Since the previous interest rate decision (on May 27) up till June 25, share prices on the stock exchange rose by 1.5 percent, in line with global trends. Since the beginning of June, yield to maturity on 10-year government local-currency bonds rose by 0.6 percentage points, while yields on CPI-indexed 17-year bonds rose by 0.3 percentage points. The gap between the Israeli and US government 10-year bond yields rose by 0.06 basis points since the last interest rate decision. Israel's sovereign risk premium, as measured by the five-year CDS spread, stood at 0.17 percent, similar to the previous month.
Global background conditions: Growth in the US economy is expected to reach 2.2 percent this year, and inflation is expected to be 2.6 percent. The markets expect that the US Fed will leave the federal funds rate unchanged next month. In Europe, growth is expected to reach 2.7 percent, and inflation 2 percent. The European Central Bank, according to market assessments, is also expected to leave its interest rate unchanged next month.
The main considerations behind the decision
  At this stage, the current level of the Bank of Israel interest rate is consistent with bringing the rate of inflation back to within the target range by the end of 2007, assuming that the exchange rate remains around its current level. In any case, interest policy will be to act, under the circumstances, such that inflation stays within its range, in the future too.
  Against a background of this year's economic growth and that expected next year, according to econometric models, local prices continue to rise by the rapid rate of more than 3 percent. However, at this stage, there are no signs of inflationary pressures.
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.