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

29.10.2007
 
The Bank of Israel interest rate for November 2007 remains unchanged at 4 percent
 
The Bank of Israel announces that the interest rate for November 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) fell in September by 0.5 percent, in line with the forecasts. In the last twelve months the CPI has risen by 1.4 percent, and since the beginning of the year by 2.3 percent. In the third quarter of 2007 prices, particularly domestic prices, as calculated by the Bank of Israel, continued rising, but at a more moderate pace than in the first two quarters. At the same time, prices of imported goods rose in the third quarter due both to the depreciation of the shekel against the dollar that started in the middle of the second quarter, and the rise in commodity prices worldwide.
Inflation forecasts: Israeli forecasters expect, on average, that the inflation rate for 2007 will reach 2.3 percent, and that inflation over the next 12 months will be 1.9 percent. At the same time they expect, on average, that the Bank of Israel’s interest rate in a year's time will be 4.3 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 2008. The Bank of Israel's models indicate that assuming the interest rate remains for now at 4 percent and the exchange rate stays at its current level, inflation twelve months from now will be close to the middle of the target range.
Real economic activity: The trend in economic growth of recent years continued in the first half of 2007 and is expected to continue in the second half too. According to the latest estimates of the Central Bureau of Statistics (CBS), GDP is expected to grow by 5.2 percent in 2007. According to the Bank of Israel forecasts, GDP is expected to grow in 2008 by more than 4 percent. There are, though, data that point to a possible deceleration in economic activity: for example, the composite state-of-the-economy index which rose in September by 0.3 percent, as a result of the fall in the manufacturing output index for August. However it is too early to determine the significance of such data for the trend in economic growth.
Labor market and wages: According to the Labor Force Survey trends, the rate of unemployment in July-August stood at 7.8 percent, compared to 7.7 percent in the preceding months. National Insurance data indicate a continued rise in the number of salaried employees and a more moderate increase in wages. In the period May-July, real wages rose by 3 percent compared to the parallel period of last year, down from 3.5 percent in the period February-April. At the same time, the trend of rising unit labor costs which began in the third quarter of 2006 continued in the third quarter of 2007.
Budget policy: The budget performance so far this year is consistent with a deficit of less than 1 percent of GDP in 2007. The cumulative government budget surplus since the beginning of the year stands at NIS 7.7 billion, compared to a surplus of NIS 2.6 billion in the corresponding period of last year. The proposed budget for 2008, which was approved by the government in August, and which passed its first reading in the Knesset, is consistent with the government's multi-year budgetary targets.
Forex market: Since the previous interest rate decision on September 23 up till October 28, the shekel strengthened by 1.1 percent against the dollar and weakened by 0.6 percent against the euro. The strengthening of the shekel against the dollar was supported by nonresidents' sale of foreign currency through short-term instruments and the continued inflow of long-term capital. The underlying forces acting to strengthen the shekel––the surplus in the current account of the balance of payments and foreign investment in the economy––continue to operate.
Capital market: Since the previous interest rate decision the Tel Aviv 25 share index rose by 11 percent. At the same time the yield on 10-year unindexed government bonds remained stable around the level of 5.6 percent. The gap between yields on 10-year unindexed government bonds in Israel and on 10-year US government bonds widened to 1.3 percentage points from 1 percentage point in the previous month. This widening stemmed mainly from the fall in yields in the US. Israel's sovereign risk premium as measured by the five-year CDS spread continued to fall, from 0.3 percent at the time of the previous discussion to 0.22 percent.
Global background conditions: The repercussions of the crisis in the financial markets that began in July continued in the past month. Despite the partial recovery seen in the financial markets, pressure remains in some of them. Financing difficulties created following the crisis have declined but still exist, and are slowing down the rate of recovery in the markets. At the same time the degree of uncertainty over global growth continues. The International Monetary Fund revised its forecast of global growth downward for 2008 while leaving its forecast for 2007 unchanged. Increases in food and oil prices point to the risk of higher inflation around the world. Despite this, the financial markets expect that the US Fed will cut its federal funds rate by 25 basis points at each of its next two meetings, while the central banks of Europe and Japan are expected to leave their interest rates unchanged at their next meetings.
The main considerations behind the decision
  There are currently opposing forces acting on inflation. On the one hand, domestic prices are rising in Israel against a background of continued rapid growth, and with it, a narrowing output gap, together with rising prices of certain imported goods following the rise in energy and food prices worldwide. On the other hand, it is expected that prices affected by developments in the exchange rate will become more moderated against a background of continued weakness in the dollar worldwide and the expected cut in the Fed interest rate.
  As a result, the current level of interest rate is consistent with the achievement of the inflation target over the coming twelve months. This is based on assessments derived from the capital market, from private forecasters, and from the Bank of Israel’s models.
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.
 
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