The Bank of Israel reduces the interest rate for February 2009 by 0.75 percentage points to 1 percent

The Bank of Israel reduces the interest rate for February 2009 by 0.75 percentage points to 1 percent
The Bank of Israel announces that the interest rate for February 2009 will be reduced by 0.75 percentage points to 1 percent.
Background conditions
Inflation data:The Consumer Price Index (CPI) declined by 0.1 percent in December, a smaller drop than the forecasts, which on average had predicted a decline of 0.4 percent. In 2008 the CPI rose by 3.8 percent. The fall in world energy prices continues to play a major role in the reduction of the index, while housing prices continue their upward trend that started in August 2008. In line with the worldwide situation, food prices declined relatively moderately in December.
Inflation and interest rate forecasts: Forecasters' inflation expectations for one year ahead averaged 0.4 percent in January, whereas expectations calculated from the capital market, which had shown a downward trend, rose in January, and in the last week reached 0.8 percent, slightly below the lower limit of the inflation target range. Forecasters' average interest rate expectations for the next month are for a reduction of 44 basis points, while expectations derived from the capital market are for a reduction of about 50 basis points for February 2009, no change in March, and a moderate rise from April.
Real economic activity: This month's data depict an intensification of the slowdown. The composite state-of-the-economy index dropped by 1 percent in December, mainly due to the decline in the exports and in the trade and services revenue indices. The Bank of Israel Companies Survey for the fourth quarter of 2008 confirms the worsening of the slowdown, and shows expectations that activity will continue to fall in the first quarter of 2009. Exports slumped in the last quarter of 2008, at an annual rate of more than 35 percent in dollar terms. Private consumption, which hitherto had remained stable, recently showed a decline. The Bank of Israel adjusted its forecast of growth in 2009 downwards, to a negative 0.2 percent, compared with its previous forecast of a rise of 1.5 percent.
The labor market and wages: : The downward trend in health tax revenues compared with the equivalent period in 2007 continued in November and December, indicating a drop in total wage payments, and hence a slowdown in the labor market. The Employers' Survey of the Ministry of Industry, Trade and Labor shows that the reduction in the number of vacancies accelerated. According to the survey, the number of vacancies fell by 45 percent from its level in the previous quarter, and the balance of employment was negative for the first time since the end of 2003. National Insurance Institute data to October point to a standstill in employment and a fall in the nominal wage in August–October 2008 compared with that in May–July. On the other hand, unemployment trend data for November indicate that the previous level of 5.9 percent was maintained.
Budget policy: Government expenditure increased sharply and unexpectedly in December, and exceeded the path consistent with the achievement of a deficit below the ceiling of 1.6 percent of GDP by NIS 4.4 billion. Thus, 12.7 percent of the total expenditure in 2008 was spent in December. The total deficit in 2008 came to 2.1 percent of GDP, above the ceiling. This resulted from a shortfall of NIS 5 billion in tax revenues. Indirect tax revenues were 10.5 percent lower in the fourth quarter of 2008 than in the fourth quarter of 2007 in real terms. Over the same period direct tax revenues were a real 16.1 percent lower than a year earlier.
The foreign exchange market:In the period between the monetary policy discussions of 28 December and 25 January, the shekel strengthened by 4 percent in terms of the index of the effective exchange rate (weighted by the volume of trade) and by 6 percent against the euro. The shekel weakened by 2.5 percent against the dollar, which strengthened against most of the major currencies by an average of about 6 percent.
The capital and money markets: Between the interest rate discussions of 28 December and 25 January, the Tel Aviv 25 and the Tel Aviv 100 share price indices rose by 2 percent and 7 percent respectively, while share indices abroad recorded falls. In this period yields on 10-year unindexed Israel government bonds remained steady at about 5 percent. Yields on US government 10-year bonds rose by half a percentage point to 2.6 percent, so that the yield gap between the Israeli bonds and US government bonds contracted somewhat to 2.4 percentage points. Prices of Israeli corporate bonds continued to rise. The Tel-Bond 20 index rose by 5 percent, and the Tel-Bond 40 index by 15 percent. Israel's sovereign risk premium, as measured by the five-year CDS spread, rose by 0.25 percentage points to 1.9 percent, while the CDS spreads of emerging market countries showed mixed trends.
The world economy: Despite some indications of an easing of the situation last month, the recovery of the global financial system seems further away. The large injection of capital by governments into the banking systems in the US, the UK and other countries has not yet stabilized the financial system, nor has it yet led to a significant renewal of credit activity or stimulation of economic activity. Financial statements starting to appear substantiate previous concerns. Economic activity: In the last month already pessimistic growth forecasts continued to decline, and the expected time of recovery is receding. The most recent data indicate rising unemployment and a sharp fall in consumers' and businesses' confidence. The earlier assessment that the emerging market countries would make up for the slowdown in the advanced economies is not being realized, as the forecasts regarding their economies are also becoming much more pessimistic. In order to deal with the recession, governments world wide are undertaking fiscal expansion, with significant increases in their deficits. Inflation: Inflation in the US in 2008 was 0.1 percent, and in the eurozone, 1.6 percent. The ECB and the Bank of England cut their interest rates by half a percentage point this month, and the markets reflect expectations of further cuts. The interest rates of the Fed and the Bank of Japan are at zero levels.
The main considerations behind the decision
The reduction of the interest rate for February by 0.75 percentage points will help strengthen the economy’s ability to cope with the effects of the global economic crisis, the major ones being the impact on demand for Israel's exports and production, and the significant slowdown in economic activity. The decision serves to encourage real economic activity, contributes to the stability of the financial system, and serves to moderate the downward pressure on prices that threaten to pull inflation below the target range of price stability. The main considerations behind the decision are:
  Forecasts of growth in the global economy have been reduced significantly in the last month. The effects of the global crisis on real economic activity in Israel are evident, with the data indicating a marked decline in demand and economic activity. World trade, which exerts a major influence on domestic activity, has dropped, and is expected to fall further. Against this background the Bank of Israel has revised its forecast of growth in 2009 to a negative 0.2 percent.
  Inflation continues to fall. The CPI declined by 0.1 percent in December, the second month in succession with a negative change in the index. Prices of imported commodities, the main cause of the rise in inflation in the first half of 2008, continue to moderate, and some are actually falling. The average of forecasters' inflation expectations for the next twelve months and expectations calculated from the capital market average are below the inflation target range of 1–3 percent a year.
  Many central banks have cut their interest rates to unprecedentedly low levels, and the capital markets expect further cuts in a number of leading economies.
The reductions in the interest rate combined with the other programs being activated by the Bank in the monetary sphere are intended to support financial stability, help cut the cost of credit, and strengthen the economy’s ability to handle the fall in demand.
The Bank of Israel will continue to monitor Israeli and worldwide economic developments closely, and will employ whatever additional instruments are necessary to achieve its objectives and thus support the stability of the financial system and encourage employment and growth.