The Bank of Israel reduces the interest rate for January 2009 by 0.75 percentage point to 1.75 percent

The Bank of Israel reduces the interest rate for January 2009 by 0.75 percentage point to 1.75 percent
The Bank of Israel announces that the interest rate for January 2009 will be reduced by 0.75 percentage point to 1.75 percent.
Background conditions
Inflation data: The Consumer Price Index (CPI) declined by 0.6 percent in November, in line with forecasters' expectations. Since the beginning of 2008 the CPI has risen by 3.9 percent, and in the last twelve months by 4.5 percent. The index excluding food, energy and fruit and vegetables rose by 1.8 percent in the last twelve months, and in November it dropped by 0.3 percent.
Inflation and interest rate forecasts: The downward trend in twelve-month inflation expectations derived from the capital market and those of forecasters, a trend that started in the second half of September, continued in November, and those expectations averaged –0.85 percent and 0.5 percent respectively. Average interest rate expectations derived from the capital market are for a reduction of about 40 basis points for January 2009, and forecasters' expectations are on average for a reduction of 60 basis points.
Real economic activity: The continued slowdown in global economic activity and the impact on the global financial system are having the effect of slowing economic activity also in Israel. Following the slowdown in the growth rate in the third quarter, data relating to the fourth quarter indicate a standstill––or even a reduction––in economic activity. Thus, the composite state-of-the-economy index, which after falling in the last few months fell by another 0.4 percent in November, shows that the slowdown in the rate of growth that started in the second quarter of 2008 is continuing. The trade and services revenue index declined by 2.2 percent in October. Sales in chain stores, imports of consumer goods and VAT on domestic production declined by 1.6 percent, 2.2 percent, and 4.1 percent respectively. Purchases via credit cards, however, increased in November by 0.3 percent.
The labor market and wages: : Initial data from the Ministry of Industry, Trade and Labor survey of employers for the fourth quarter show a significant decline in the number of vacancies in the business sector, a rise in the number of employment terminations, and a decline in jobs filled. Health tax revenues––a useful indicator of the level of employment––were 5.8 percent lower in November than the average in the months August–October. In November the number of job seekers registered at the labor exchanges rose by 2.2 percent. National Insurance Institute data for the third quarter show that the average nominal wage per employee post remained unchanged from the second to the third quarter.
Budget policy: Tax revenues in January–November were 7 percent lower in real terms than in the equivalent period in 2007. Non-tax revenues rose in this period, however, and real expenditure fell as a result of the unexpected inflation. The government is expected to meet the deficit target of 1.6 percent of GDP in 2008. To date there is underspending in nominal terms (of NIS 3.9 billion, about 2 percent of expenditure), but this is expected to fall almost to zero in December.
The foreign exchange market: In the period between the monetary policy discussions of 23 November and 28 December, the shekel strengthened by 3.5 percent against the dollar, and weakened by 7.5 percent against the euro. Against the index of the effective exchange rate (weighted by the volume of trade) the shekel weakened by about 1 percent. In this period the dollar weakened against most of the major currencies at rates of up to more than 13 percent.
The capital and money markets: Between the interest rate discussions of 23 November and 28 December, the Tel Aviv 25 and the Tel Aviv 100 share price indices maintained their relative stability, and even rose slightly, in contrast to their falls in the previous period. Share indices abroad also remained relatively calm in this period, with a slight upward trend. In this period yields on 10-year unindexed Israel government bonds fell by 1.4 percentage points to about 5 percent. Yields on US government 10-year bonds continued to decline, and this month fell by 1.1 percentage points to 2.1 percent, so that the yield gap between the Israeli bonds and US government bonds contracted slightly to 2.9 percentage points. Prices of Israeli corporate bonds rose slightly in this period. The Tel-Bond 20 index rose by 5 percent, and the Tel-Bond 40 index by 7 percent. Israel's sovereign risk premium, as measured by the five-year CDS spread, fell by 0.15 percentage points to 1.6 percent. The CDS spreads of emerging market countries also showed similar declines.
The world economy: Following decisive steps taken by various authorities around the world, pressure in the financial markets eased to some extent recently. Nonetheless, the level of uncertainty apparently remains high. Economic activity: Most data on the global economy still paint a negative picture. Many countries have already posted two quarters or more of negative growth––that is to say, they are in recession––and forecasts are pessimistic. The World Bank assessment is that global growth in 2009 will reach only 0.9 percent, and there is a risk that this forecast may be adjusted downward. The World Bank expects world trade to decline by 2.1 percent in 2009. Its forecast for 2010 is more optimistic––global growth of 3 percent, and a surge in world trade. The IMF, which a few weeks ago published its global growth forecast for 2009 of 2.2 percent, announced that in January it expects to lower its forecast. Inflation: The sharp falls in commodity and energy prices together with the economic slowdown resulted in a marked drop in inflation itself and concern over inflation. That concern was replaced by concern over price falls. Against this background central banks around the world accelerated the rate of their interest rate cuts and are expected to continue reducing interest rates rapidly to unprecedentedly low levels. Thus the Fed cut its rate by 75 basis points to a target range of 0 to 1/4 percent, the Bank of England reduced its bank rate by 1 percentage point to 2.0 percent, and the Bank of Japan cut its rate by 0.2 percentage points to 0.1 percent.
The main considerations behind the decision
The reduction of the interest rate for January by 0.75 percentage point will help strengthen the economy’s ability to cope with the implications of the global economic crisis and support real activity. It is consistent with the return of inflation to the target range of 1–3 percent within the next few months. The main considerations behind the decision are:
  The effects of the global crisis on real economic activity in Israel are evident. Data on real activity point to a marked slowdown in growth, and some indicators even suggest a reduction in activity.
  The inflation environment has fallen. Forecasters expect inflation in 2009 to be below the lower limit of the target range. Expectations derived from the capital market are also for price reductions in 2009. These forecasts indicate a return to within the target inflation range as early as in the first third of 2009, although the inflation rate is expected to fall below the target range later in the year.
  Last month many central banks cut their interest rates sharply, in some cases to unprecedentedly low levels, and the capital markets expect further cuts in a number of leading economies.
  The security-related developments of the last few days have opposing effects. On the one hand they increase geopolitical uncertainty in Israel, and on the other they have the potential to impact negatively on real activity.
The current reduction in the interest rate is intended to help cut the cost of credit and to strengthen the economy’s ability to handle the slowdown in economic activity and the implications of the global economic crisis.
The Bank of Israel will continue to monitor Israeli and worldwide economic developments closely, and will take whatever steps are necessary to support the stability of the financial system and to encourage employment and growth, as long as inflation continues to decline towards and achieve the price stability target.