The Bank of Israel raises the interest rate for June 2008 by 25 basis points to 3.5 percent

The Bank of Israel raises the interest rate for June 2008 by 25 basis points to 3.5 percent
The Bank of Israel announces that the interest rate for June will rise by 25 basis points, to 3.5 percent. This step is taken in the context of the policy of maintaining price stability, in accordance with the inflation target of 1-3 percent a year.
Background conditions
Inflation data: The Consumer Price Index (CPI) rose by 1.5 percent in April, above the expected increase of 0.9 percent. In the last twelve months the CPI has risen by 4.7 percent, and the CPI excluding the energy, food, and fruit and vegetables components by 2 percent, 0.9 percentage points more than the level in March. Although much of the rise in prices is the result of the global increase in food and oil prices, even after adjusting for the effect of those prices, the inflation environment has worsened significantly.
Inflation and interest rate forecasts: Israeli forecasters revised their predictions upwards again this month, and expect, on average, that inflation over the next twelve months will be 3.3 percent, i.e., above the upper limit of the target range. They have also raised their forecasts for the next few months significantly. They also expect that the Bank of Israel will raise the interest rate for June by between 25 basis points and 50 basis points, and again by a similar amount for July. Inflation expectations for the next twelve months calculated from the capital market currently stand at 2.8 percent, close to the upper limit of the target range. Interest rate expectations derived from the capital markets indicate a cumulative rise of one percentage point over the next twelve months.
Real economic activity: National Accounts data relating to the first quarter of 2008 indicate that economic growth is continuing, but at a slightly slower rate than in the previous four quarters. In 2008:Q4 GDP increased at annual rate of 5.4 percent, and business sector product at an annual rate of 6.1 percent. However, deducting the effect of import taxes, the growth rate was a more moderate 4.2 percent. In the first quarter imports and exports increased considerably. The composite state-of-the-economy index for April edged up by 0.1 percent, and the indices for February and March were revised upwards.
The labor market and wages: Employment continued to rise during the last few months. At the same time the rise in nominal labor costs accelerated. According to National Insurance Institute data, the number of employee posts kept rising, albeit a little more slowly. In the three months December 2007 to February 2008 the number rose by 4 percent compared with the number in the same months a year earlier. According to trend data of the Manpower Survey, the unemployment rate was 6.5 percent in February. The nominal wage accelerated: in the public sector it rose by 8.9 percent in the three months December 2007 to February 2008 compared with that in the same months a year earlier, partly due to the payment of various non-recurring wage components following the new wage agreement; in the business sector the nominal wage rose over the same period by 3.6 percent.
Budget policy: Budget data for the first four months of the year are consistent with the full implementation of the budget. On the revenues side the rise in direct tax revenues slowed, while import taxes and non-tax revenues rose. In this period total government revenues were higher than budgeted.
The foreign exchange market: In the period between the previous interest rate discussion on 27 April, and 25 March, the shekel strengthened by 3.8 percent against the dollar and by 3.4 percent against the euro. Most of the major currencies tended to strengthen against the dollar this month. During the last month the volatility of the shekel/dollar exchange rate declined. The trend emerging in the goods ands services account suggests that a turnaround in the current account is under way, and that it will move from a surplus of about $5 billion in 2007 to a small deficit in 2008. Such a change would tend to weaken the forces acting to strengthen the shekel.
The capital and money markets: The leading stock exchange indices around the world showed mixed trends this month. From 27 April (the date of the previous interest rate discussion) to 25 May, the Tel Aviv 100 share price index showed no significant change. Yields on 10-year unindexed government bonds rose again, slightly, and reached 5.94 percent, compared with 5.89 percent last month. The yield gap between Israeli and comparable US government bonds remained steady at 2.1 percentage points. Israel's sovereign risk premium, as measured by the five-year CDS premium, continued to decline this month and reached 0.52 percent, down from 0.6 percent last month. A similar decline occurred in the CDS spreads in the emerging markets.
The world economy: The global economy is currently in a state of uncertainty on three fronts: the situation in the financial sector, the expected slowdown in the growth of economic activity, and the surge in inflation. Following a period of upheaval in the financial sector, a measure of calm has returned, but uncertainty regarding the financial markets is still evident. The most recently published economic data indicate a slowdown in world growth, and especially in growth in the US. The rate of growth in Europe and Japan showed a surprising increase in the first quarter of 2008, but it is expected to moderate. Global inflation continues to accelerate, in light of the marked rises in commodity and oil prices. Prices of many commodities reached record levels this year. However, some commodity prices did drop in the last month, but oil prices, which reached an unprecedented $135 a barrel, continue to rise. Market assessments, and those of the IMF, are that food and commodity prices will remain at their present high levels. If these assessments turn out to be correct, inflation would be expected to slow. Against the background of the increase in inflation, expectations of changes in central banks' interest rates also rose. Financial market prices imply no change in the Fed interest rate at its next meeting (with a probability of more than 90 percent) and a rise of 25 basis points (with a high degree of probability) in the ECB and Bank of Japan interest rates by the end of the year.
The main considerations behind the decision
  This increase in the interest rate is required due to the worsening of the inflation environment. Thus, inflation in the last twelve months was 4.7 percent, compared with the target range of 1-3 percent, and one-year-forward inflation expectations derived from the capital market are at the upper limit of the target range. In addition, the average of Israeli forecasters' twelve-month inflation predictions is above the upper limit of the target range.
  The decision to raise the interest rate by 25 basis points was based mainly on the assessment that despite the relatively rapid growth in the first quarter, a slowdown in growth is still expected this year due to the slowdown expected in the global economy.
  The Bank of Israel also considers that the appreciation of the shekel has a moderating effect on prices, but to a lesser extent than hitherto. The stronger shekel also tends to have a moderating effect on real activity.
This increase in the interest rate is required to return inflation to the price stability target range of 1-3 percent inflation a year, and thereby to provide the basis that is essential for sustained growth.
The Bank of Israel will continue to monitor economic developments worldwide and will raise the interest rate as necessary to achieve price stability. 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.

The minutes of the discussions prior to the above interest rate decision will be published on 10 June 2008.
The decision regarding the interest rate for July 2008 will be published at 18:30 on 23 June 2008.