The Bank of Israel interest rate for October 2007 nremains unchanged at 4 percent

24.9.07
 
The Bank of Israel interest rate for October 2007 remains unchanged at 4 percent
 
The Bank of Israel announces that the interest rate for October 2007 will remain unchanged at 4 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) rose in August by 0.7 percent, in line with the forecasts. In the last twelve months the CPI has risen by 1 percent, and since the beginning of the year by 2.8 percent. In the third quarter of 2007 domestic prices, i.e., prices not directly affected by changes in the shekel exchange rate, as derived from the Bank of Israel's econometric models, continued rising at a rate above the upper bound of the inflation target range, and the import component of prices also rose, due to the depreciation of the shekel against the dollar that started in the second quarter.
Inflation forecasts: Israeli forecasters expect, on average, that the inflation rate for 2007 will reach 2.6 percent, and that inflation over the next 12 months will be 1.6 percent. At the same time they expect, on average, that the Bank of Israel’s interest rate in a year's time will be 4.5 percent. The expectation of inflation over the next 12 months derived from rates of return in the capital market is around 1.2 percent, and, based on financial markets data, the interest rate is expected to rise by 0.5 percentage points in that period. The Bank of Israel's econometric models indicate that assuming an interest rate of 4 percent and the exchange rate at its current level, inflation twelve months from now will be close to the middle of the target range.
Real economic activity: The high rate of economic growth continues. According to the National Accounts estimates of the Central Bureau of Statistics (CBS), GDP is expected to rise by 5.1 percent in 2007. The composite state-of-the-economy index rose in August by 0.7 percent, indicating continued growth
Labor market and wages: The rate of employment rose by 0.5 percentage points from the first quarter of the year to the second, and reached 52.3 percent; unemployment fell to 7.6 percent, and according to the CBS estimates is expected to reach 7.4 percent at the end of 2007. The real wage per employee post was 4.4 percent higher in 2007:Q2 than in 2006:Q2. At the same time, as labor productivity flattened out and labor costs rose in 2007:Q2, unit labor costs were 3 percent higher than in the first quarter.
Budget policy: The cumulative government budget surplus since the beginning of the year stands at NIS 7.6 billion. The budget performance so far this year is consistent with a deficit of less than 1 percent of GDP in 2007.
Forex market: Since the previous interest rate decision on August 28 up till September 23, the shekel strengthened by 2.3 percent against the dollar and by 0.2 percent against the euro. The underlying forces acting to strengthen the shekel of the shekel––notably the surplus in the current account of the balance of payments and foreign investment in the economy––continue to apply. In addition, the real exchange rate of the shekel against the basket of currencies weighted in accordance with Israel’s foreign trade is presently at about its level at the beginning of the year.
Capital market: Since the previous interest rate decision the index of prices of the leading shares on the Tel Aviv Stock Exchange rose by 2.3 percent . At the same time the yield on 10-year Shahar bonds dropped by 0.28 percentage points. The gap between yields on 10-year bonds in Israel and on 10-year US government bonds contracted to one percentage point, down from 1.45 percentage points in the previous month, but remained significantly higher than in April–May. Israel's sovereign risk premium as measured by the five-year CDS spread declined from 0.33 percent at the time of the previous discussion to 0.27 percent.
Global background conditions: The crisis in the financial markets continued and spread from the US subprime mortgage market to other financial markets in the US and Europe. At the same time the degree of uncertainty over global growth increased, as did expectations of a slowdown in the US and European economies. Increases in food and oil and other commodity prices point to the risk of higher inflation around the world. As a result of the financial market turbulence and its implications, the Federal Open Market Committee cut the interest rate by 0.5 percentage points, and the ECB left its interest rate unchanged. Investment houses expect the high global growth rate, combined with the policy of central banks throughout the word, to help overcome the crisis.
The main considerations behind the decision
  Based on assessments derived from the capital market, from private forecasters, and from the Bank of Israel’s econometric models, the decision not to change the interest rate is consistent with the achievement of the inflation target over the coming twelve months.
  It appears that the effect on prices of the weakness of the dollar against the shekel is, at present, offsetting the inflationary pressures expressed by the rise in domestic and other prices, such as those of electricity, oil, food, etc., and supports the assumption that the rate of inflation is likely to be within the price-stability target. This, against the background of the worldwide weakness of the dollar, the surplus in Israel’s balance of payments, the continued flow into Israel of investments by nonresidents, and the contraction of the interest rate differential between the NIS and the dollar resulting from the 50 basis point cut in the US interest rate.
  If the expectation of some slowdown in growth in the US in the last quarter of 2007 and the first half of 2008 is confirmed, it would tend to reduce demand and prices in the Israeli economy, which would contribute to keeping inflation within the target range.
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.