The Bank of Israel reduces the interest rate for March 2009 by 25 basis points to 0.75 percent

23.2.2009
 
The Bank of Israel reduces the interest rate for March 2009 by 25 basis points to 0.75 percent
 
The Bank of Israel announces that the interest rate for March 2009 will be 0.75 percent.
In addition, The Bank is narrowing the interest rate corridor in the credit window and the commercial banks' deposit window from ±0.5 percent to ±0.25 percent.
   
Background conditions
Inflation data: The Consumer Price Index (CPI) declined by 0.5 percent in January, close to the average of the forecasters predictions. In the last twelve months the CPI rose by 3.3 percent, and in the last three months it fell by 1.2 percent.
Inflation and interest rate forecasts: Forecasters' inflation expectations regarding the CPI in February and March are for a drop of one-tenth of a percent in each. Their forecasts for twelve months forward on average are for of a rise of 0.7 percent, while twelve-month expectations calculated from the capital market are for an increase of 0.8 percent. Forecasters expect that that the interest rate will reach an unprecedentedly low level in March, with an average prediction of 0.5 percent. Expectations derived from the capital market are for reductions in the next two months that will bring the interest rate close to zero. The forecasters expect the interest rate to start rising again, and on average predict a level of 0.9 percent one year hence, while according to expectations from the capital market it will reach a level of 1.3 percent one year from now.
Real economic activity: National Accounts data for the last quarter of 2008 show negative growth at an annual rate of 0.5 percent. Exports in the last quarter of 2008 declined by 13 percent, that is to say, at an annual rate of 43.6 percent. Monthly data published last month add weight to the indications of the slowdown that started a few months ago. Further to its falls in the last few months, the January composite state-of-the-economy index recorded its steepest drop so far, 1.2 percent, with declines in the indices of goods exports, capital goods imports, raw material imports, and trade and services revenue.
The labor market and wages: The downward trend in health tax revenues continued in January, with a real decline of 2.5 percent compared with January 2008, indicating a drop in total wage payments, and hence a slowdown in the labor market. Employment Service data for January show a rise of 3.8 percent in the number of work seekers compared with the number in December, continuing the rise in the second half of 2008. At the same time, various indicators show a decline in the demand for labor. In November–January the real wage fell by 1.3 percent compared with the equivalent period a year earlier, while the nominal wage rose by 3.1 percent.
Budget data: The downward trend in tax revenues persisted in January, and they were 19 percent lower, in real terms, than in January 2008, and NIS 1.5 billion lower than the level for the month (0.2 percent of annual GDP) consistent with the forecast seasonal path of tax revenues in 2009. That said, the limitation restricting expenditure to one-twelfth of the previous year's budget until the 2009 budget is approved resulted in a surplus of NIS 1.5 billion on government activity in January.
The foreign exchange market: In the period between the monetary policy discussions of 25 January and 22 February, the shekel weakened against the dollar by 4.7 percent, and against the euro by 2.6 percent. In terms of the index of the effective exchange rate (weighted by the volume of trade) the shekel weakened by 2.5 percent. In that period the dollar strengthened against most of the major currencies, albeit more moderately than against the shekel.
The capital and money markets: Between the interest rate discussions of 25 January and 22 February, the Tel Aviv 25 and the Tel Aviv 100 share price indices rose by 8.5 percent and 10 percent respectively, mainly due to the steep rise in the shares of oil and gas exploration companies. In this period stock markets around the world showed mixed trends. Following the announcement by the Bank of Israel that it would start buying government bonds on the secondary market, yields on 10-year unindexed Israel government bonds fell by 0.62 percentage points to 4.41 percent. Since the last monetary discussions, yields on US government 10-year bonds rose by 0.13 percentage points to 2.79 percent, so that the yield gap between the Israeli bonds and US government bonds contracted to 1.62 percentage points. Prices of Israeli corporate bonds continued to rise, among other things, as a result of the planned Ministry of Finance "leverage" (investment) funds. The Tel-Bond 20 index rose by 2.6 percent, and the Tel-Bond 40 index by 5.7 percent. Israel's sovereign risk premium, as measured by the five-year CDS spread, rose by 0.55 percentage points to 2.4 percent, and the CDS spreads of advanced economies and emerging market countries also widened.
The world economy: The crisis in the global financial system continued, and became even more severe. The expansionary measures taken by governments and central banks around the world led to some improvement in the money and credit markets, but this effect was not uniform, and it was confined to the areas in which the authorities intervened. Uncertainty in the financial markets remains at a high level. Economic activity: The slowdown in global growth has intensified, against the background of the sharp fall in demand. Most of the advanced economies are already in recession, which is expected to deteriorate further, to be followed by a slower recovery process than previously anticipated. The list of countries that have announce rescue plans and a switch to expansionary fiscal policy, with significant increases in budget deficits, is growing. Inflation: Inflation and inflation expectations are falling in light of the persistent slowdown in global demand and the drop in commodity, particularly oil, prices. Last month oil prices fell by 16 percent. The IMF predicts a marked decline in inflation in 2009. Against this background, many central banks are continuing to pursue expansionary monetary policies. However, due to the fact that in some countries the interest rate is close to zero, central banks are actively engaged in examining alternative policy measures.
The main considerations behind the decision
The reduction of the interest rate for March by 0.25 percentage points and the narrowing of the interest rate corridor will help strengthen the economy’s ability to cope with the effects of the global economic crisis. The decision serves to encourage real economic activity, is consistent with 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:
  The effects of the global crisis on real economic activity in Israel are evident in their negative impact on demand for exports and production, and the marked slowdown in economic activity. Central Bureau of Statistics and other data published last month indicate that nearly all sectors of the economy reflect the negative change in economic activity in the second half of 2008. These data are in accord with forecasts of growth close to zero in 2009.
  In the last three months the rate of inflation has fallen considerably, and it is expected to continue falling. Most of the components of the CPI show price declines. Forecasts of inflation in the next twelve months, both those of forecasters and those derived from the capital market, are below 1 percent, the lower limit of the price stability target range.
  Many central banks have cut their interest rates to unprecedentedly low levels, and the capital markets reflect expectations that expansionary monetary policies will continue. At the same time, as part of their expansionary monetary policies, central banks are using additional monetary instruments.
With the interest rate now at an unprecedentedly low level, the Bank of Israel will focus on the use of additional instruments that lead to monetary expansion.
Concurrently the Bank has narrowed the interest rate corridor in the credit window and the commercial bank deposit window from ±0.5 percent to ±0.25 percent.
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 of price stability, the encouragement of employment and growth and support for the stability of the financial system.