The Bank of Israel leaves the interest rate unchanged for May 2009

27.4.2009
 
The Bank of Israel leaves the interest rate unchanged for May 2009
 
The Bank of Israel announces that the interest rate for May 2009 will remain unchanged at 0.5 percent.
Background conditions
Inflation data: The Consumer Price Index (CPI) rose by 0.5 percent in March, after four months of negative changes. The increase exceeded the average of forecasters' predictions of a rise of 0.2 percent. Since the beginning of 2009 the CPI has declined by 0.1 percent, and over the last twelve months it rose by 3.6 percent.
Inflation and interest rate forecasts: The averages of forecasters' predictions regarding the CPI are for an increase of 1.0 percent in April and 0.2 percent in May. Their forecasts are that inflation over the previous twelve months will return to within the target range as early as next month, and in a year's time will be around the lower limit of the range. Since the publication of the CPI for March, inflation expectations for twelve months forward derived from the capital market have risen slightly, and last week reached 0.8 percent, below the lower limit of the inflation target. Expectations derived from the capital market regarding the Bank of Israel's interest rate for May are for a cut of 25 basis points, and for a rate of 1.4 percent a year hence. On average, forecasters expect the interest rate for May to remain unchanged, and to be 1 percent one year hence.
Real economic activity: Further to the contraction of real activity in the last quarter of 2008, initial indicators relating to the first quarter of 2009 point to a continued decline, due mainly to a fall in world demand. Last week the Bank of Israel reduced its forecast of growth in Israel in 2010 to +1 percent. The composite state-of-the-economy index for March showed a reduction of 0.9 percent, continuing the reductions shown in the last few months. It is worth noting that this represents a slight increase compared with the negative trend. The Companies Survey for the first quarter of 2008, to be published in the next few days, shows further contraction of activity. For the next quarter, however, participants in the survey expect a more moderate decline than that in the first quarter. The Purchasing Managers Index also indicates a low level of activity, although in the last two months it showed some improvement, following its sharp fall in January.
The labor market and wages: The crisis is affecting the labor market, but with a lag. The unemployment rate rose in January to 6.8 percent. In the first quarter of 2009 claims for unemployment benefit increased by 20 percent, and in March alone, by 10 percent. The Employers Survey for the first quarter presents a similar picture: the employment gap, i.e., the difference between the number of positions filled and the number of terminations of employment, deteriorated seriously, with a negative balance of 40,000, compared with a negative 10,000 in the previous survey. Despite the weakness in the labor market, the average wage per employee post increased by 1.1 percent in January.
Budget data: The budget deficit (excluding credit) in the first quarter of 2009 was NIS 4.8 billion, in contrast to large surpluses in the first quarter of every year since 2004. Deducting the effect of changes in tax rates, in the first quarter of 2009 tax revenues fell by a real 16 percent compared with the first quarter of 2008. The need to ensure the continuation of the downward path for the deficit and an expenditure constraint appears as one of the principles of the economic program presented by the Prime Minister and the Minister of Finance.
The foreign exchange market: In the period between the monetary policy discussions of 22 March and 26 April, the shekel weakened against the dollar by 4.8 percent, and against the euro by 2.3 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 4.9 percent. The weakness of the shekel against the dollar was mainly the result of the strengthening of the dollar against the major currencies and of the Bank of Israel's announcement that it was continuing its daily purchases of foreign currency.
The capital and money markets: Between the interest rate discussions of 22 March and 26 April the Tel Aviv 25 share price index rose by 12 percent and the Tel Aviv 100 index by 13 percent. In this period stock markets around the world generally recorded sharp increases. In the first two weeks of the period, in light of the Bank's announcement that it was increasing the scale of its purchases of government bonds, the yield curve flattened and yields fell, in contrast with the rising yield trend around the world. In the second half of the period, however, yields started rising, with a marked widening of the gap between long-term and short-term yields. Over the whole of the period from the previous interest rate discussions to the present ones, yields on unindexed 10-year Israeli government bonds rose by 0.21 percentage points to 4.80 percent, and on US government 10-year bonds by 0.36 percentage points to 2.99 percent, so that over the period as a whole the yield gap between the Israeli bonds and US government bonds contracted to 1.81 percentage points. Yields on Israeli corporate bonds fell. The Tel-Bond 20 index increased by 4.4 percent, and the Tel-Bond 40 index by 6.4 percent. Israel's sovereign risk premium, as measured by the five-year CDS spread, dropped relatively sharply from 2.45 percent to 1.8 percent. The CDS spreads of emerging market countries also narrowed.
The world economy: The weakness in the global economy continued. That said, there are signs that the rate of deterioration is easing, and there may be the first indications that the situation is stabilizing, expressed mainly in the real estate market, consumption, some confidence indices published in the US, and data arriving from China. Most of the data relating to the global economy, in general, continue to be negative, in particular data of production, exports and unemployment. The IMF forecasts are that world output will decline in 2009, for the first time since the Great Depression. The OECD expects a 4.3 percent reduction in its members' GDP in 2009. Stock markets around the world continued to rise steeply this month, indicating that the financial markets consider that the global economy will return to a growth path earlier than assessed previously. Inflation: Global inflation in the next few months is expected to be lower than desired, and possibly even negative. Central banks that have not yet reached zero interest rates are continuing to cut their rates. At the same time, central banks and governments around the world are persisting with the exceptional measures they introduced and with their programs to boost activity. Nevertheless, the view is being expressed abroad that a strategy needs to be formulated that would enable a less expansionary monetary policy to be pursued.
The main considerations behind the decision
The decision to leave the interest rate unchanged for May at its current low level, together with the exceptional measures the Bank is taking––purchases in the foreign currency market and the government bond market––will help strengthen the economy’s ability to cope with the effects of the global economic crisis. The decision will serve to support real economic activity, the stability of the financial system, and the achievement of the inflation target. The main considerations behind the decision are:
  The risks that the economy will slide into deflation have declined, and in the current circumstances the probability that inflation will return to within the target range by the end of the year has increased.
  The effect of the low rate of interest combined with the other instruments that the Bank is using is evident in the financial system, among other things in the easing of the cost of credit. At this stage of the crisis, the conditions created by the Bank of Israel's policy are serving to moderate the effects of the global crisis and to help the economy recover from it.
  Negative data continue to arrive that indicate further contraction of activity, but at the same time other data point to a moderation in the rate of decline.
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–– the encouragement of employment and growth, price stability, and support for the stability of the financial system.