The Bank of Israel reduces the interest rate for April 2009 by 25 basis points to 0.5 percent

23.3.2009
 
The Bank of Israel reduces the interest rate for April 2009 by 25 basis points to 0.5 percent
 
The Bank of Israel announces that the interest rate for April 2009 will be reduced by 25 basis points to 0.5 percent.
Background conditions
Inflation data: The Consumer Price Index (CPI) declined by 0.1 percent in February, and was slightly below forecasters' predictions of no change. In the last four months the CPI fell by 1.3 percent, and in the last twelve months it rose by 3.4 percent.
Inflation and interest rate forecasts: The averages of forecasters' predictions regarding the CPI in March and April are for increases of 0.2 percent and 0.5 percent respectively. Their forecasts for twelve months forward on average are for an increase of 0.6 percent in the CPI, while twelve-month expectations calculated from the capital market are for an increase of 0.7 percent. Inflation expectations for two years forward and beyond derived from the capital market rose, and are currently around the middle of the inflation target range. Forecasters' expectations regarding the Bank of Israel's interest rate for April range from no change to a cut of 25 basis points. On average, they expect the interest rate to be 1 percent one year hence. Expectations derived from the capital market are on average for a reduction of 20 basis points in the interest rate for April, and interest of 1.8 percent in one year's time.
Real economic activity: The data relating to the end of 2008 and the beginning of 2009 indicate a contraction of economic activity, with a concurrent significant drop in both export and domestic demand. In the first two months of 2009 exports (monthly average) fell at by 8.3 percent compared with the average monthly level in the last quarter of 2008. In the fourth quarter of 2008 private consumption declined by 3.1 percent, annual rate. The composite state-of-the-economy index for February showed a reduction of 1.1 percent, and in the last six months the index has dropped sharply, by 4.5 percent. In light of the negative data relating to Israel's economy and the further downward revisions of forecasts of global growth and world trade by international organizations, the Bank of Israel reduced its growth forecast for 2009 from a negative 0.2 percent to a negative 1.5 percent.
The labor market and wages: The Manpower Survey for the last quarter of 2008 shows an increase in the unemployment rate to 6.3 percent, with a steep decline in the number of full-time employees and an increase in the number of those in part-time employment. The number of new claims for unemployment benefits in February was 60 percent higher than in February 2008. The real wage fell by 4 percent in the fourth quarter of 2008, and the nominal wage by 1.2 percent, annual rates. The downward trend in health tax revenues continued in February, with a decline of about 1 percent compared with February 2008. This decline is an indication of a reduction in total wage payments, and hence of a slowdown in the labor market.
Budget data: The budget deficit (excluding credit) in January–February 2009 was NIS 1.5 billion, compared with NIS 3.6 billion in the first two months of 2008. Assuming that the government keeps its expenditure at the legally defined ceiling, the deficit in 2009 is expected to be 5.2 percent of GDP, i.e., NIS 37 billion. The downward trend in tax revenues persisted in February and, excluding the effects of changes in tax rates, they were 17 percent lower, in real terms, than in February 2008. This resulted from a decline in both direct and indirect tax revenues.
The foreign exchange market: In the period between the monetary policy discussions of 22 February and 22 March, the shekel strengthened against the dollar by 3.3 percent, to NIS 4.02 to the dollar, and weakened against the euro by 5 percent. In terms of the index of the effective exchange rate vis-?-vis the currencies of Israel's trading partners (weighted by the volume of trade), the shekel weakened by 0.5 percent. In that period the dollar weakened against most of the major currencies by more than it did against the shekel.
The capital and money markets: Between the interest rate discussions of 22 February and 22 March, the Tel Aviv 25 and the Tel Aviv 100 share price indices fell by 1.9 percent and 2.8 percent respectively. In this period stock markets around the world generally recorded increases. Yields on government bonds, which had fallen steeply following the announcement by the Bank of Israel that it would start implementing its plan to buy government bonds on the secondary market, rose during most of this period. Towards the end of the period they started falling, following the announcement by the Fed that it would buy US government bonds and the rapid decline in yields which it caused. Yields on 10-year unindexed Israel government bonds rose by 0.23 percentage points to 4.63 percent. Since the last monetary discussions, yields on US government 10-year bonds fell by 0.15 percentage points to 2.64 percent. On 19 March the Ministry of Finance successfully launched a bond issue in the United States of $1.5 billion with a yield gap of 2.7 percentage points compared with the yield on US government bonds. Prices of Israeli corporate bonds showed mixed trends. The Tel-Bond 20 index increased by 1.4 percent, and the Tel-Bond 40 index dipped by 0.5 percent. Israel's sovereign risk premium, as measured by the five-year CDS spread, increased to 2.45 percent, whereas the CDS spreads of advanced economies and emerging market countries narrowed.
The world economy: The crisis in the global financial system continued. Authorities continued with their intervention in the financial markets, with the intention of causing them, and in particular the credit markets, to resume functioning as normal. The Fed and the Bank of England announced purchases of significant quantities of government bonds. There were signs of some reduction in indices of risk aversion, and this led to rises in stock markets around the world. Economic activity: The data relating to last month showed further deterioration in the global recession. The IMF expects global GDP to increase by 0.5 percent in 2009. Inflation: Global inflation in the next few months is expected to be negative. That said, the recent rises in oil prices are likely to lead to a rise in the inflation rate. The Fed, the Bank of England and the Bank of Japan have set interest rates at around zero, and the rates of some other central banks are converging to that level. Together with those zero-level interest rates, central banks are using additional instruments to bring about monetary expansion.
The main considerations behind the decision
The reduction of the interest rate for April by 0.25 percentage points will help strengthen the economy’s ability to cope with the effects of the global economic crisis. This reduction will serve to encourage real economic activity, is consistent with the stability of the financial system, and will serve to moderate the downward pressure on prices that is likely to pull inflation below the target range of price stability. The main considerations behind the decision are:
  Data that became available during the last month point to an increase in the severity of the recession in global and domestic economic activity. Forecasts of the extent of global activity and world trade have been revised downwards. In light of these developments, the Bank of Israel revised its forecast of Israel's growth in 2009 to a negative 1.5 percent. The effects of the global crisis are evident, among other things, in declines in exports and in domestic demand.
  The downward trend in inflation in the last few months continued in February. Forecasters' twelve-month-forward inflation expectations and those calculated from the capital market are below the lower limit of the target range. The downward trend of commodity prices evident in the last few months has, however, ended.
  Central banks around the world are continuing with their expansionary monetary policies, and the capital markets expect monetary expansion to persist. Some central banks that had not yet reached zero levels of interest cut their rates further, and some of those that have reached zero levels are employing additional instruments aimed at easing credit for households and businesses.
The Bank of Israel will continue to monitor Israeli and worldwide economic developments, and will use the instruments available to it to achieve its objectives of price stability, the encouragement of employment and growth, and support for the stability of the financial system.