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

25.5.2009
 
The Bank of Israel leaves the interest rate unchanged for June 2009
 
The Bank of Israel announces that the interest rate for June 2009 will remain unchanged at 0.5 percent.
   
Background conditions
   
Inflation data: The Consumer Price Index (CPI) rose by 1 percent in April, in line with the forecasters' expectations. Since the beginning of 2009 the CPI has risen by 0.9 percent, and over the last twelve months by 3.1 percent, slightly above the upper limit of the target range.
   
Inflation and interest rate forecasts: The averages of forecasters' predictions regarding the CPI are for an increase of 0.3 percent in May and 0.4 percent in June. According to these forecasts, inflation over the previous twelve months will return to within the target range as early as next month, and will remain within the range during the next twelve months. Since the publication of the March CPI, the increase in taxes on cigarettes and fuel, and expectations of an increase in VAT, inflation expectations for twelve months forward have risen. Those derived from the capital market in May rose to 1.9 percent, and forecasters' expectations in the last few days averaged 2.2 percent. Interest rate expectations derived from the capital market are that the rate will not change for June, and that the rate a year hence will be 2.2 percent. On average, forecasters expect the interest rate for June to remain unchanged, and to be 1.3 percent in one year.
   
Real economic activity: According to National Accounts figures for the first quarter of 2009, GDP fell at an annual rate of 3.6 percent. This is consistent with the Bank of Israel's forecast that GDP will decline by 1.5 percent in 2009; according to this forecast, growth is expected to return towards the end of the year. Imports plunged by 61.9 percent in the first quarter, and exports by 48.5 percent. Nonresidential investment also dropped sharply, by 37.6 percent, and private consumption fell by 4.3 percent (all these National Accounts figures show the change from the last quarter of 2008 to the first quarter of 2009 in annual terms). The composite state-of-the-economy index for April showed a reduction of 0.3 percent, a relatively moderate decline compared with those in the last few months.
   
The labor market and wages: The crisis is affecting the labor market, although some indicators suggest some easing in the severity of the situation. National Insurance Institute data show that the decline in the number of employee posts in the economy halted in February. The number of unemployed persons continued to increase, but the rate of increase slowed from 2.4 percent in January to 1.8 percent in March, and the rate of unemployment in February stayed at the same level as in January, 6.9 percent On the other hand, unemployment benefit payments in February and March were 59 percent higher than those in February and March 2008, and the rate of increase is accelerating. Health Tax revenues show a real decline of 3.5 percent in April compared with April 2008, probably indicating a more severe fall in wages and employment. The nominal wage per employee post dropped by 0.5 percent in February, and the real wage by 0.7 percent, compared with their January levels.
   
Budget data: In the first four months of 2009 the budget deficit (excluding credit) was NIS 7.9 billion, compared with a surplus of NIS 5.6 billion in the first four months of 2008. Government expenditure since the beginning of the year was about 10 percent (NIS 7.8 billion) lower than the level consistent with the new 2009 budget (NIS 246 billion). This was the result of the legal restriction on government spending prior to the approval of the 2009 budget. Expenditure is expected to increase significantly with Knesset approval of the budget. Tax revenues continue to fall, but the rate of decline moderated for the second consecutive month, particularly indirect tax revenues. The budget approved by the government is based on deficit targets of 6 percent of GDP in 2009, and 5.5 percent in 2010.
   
The foreign exchange market: In the period between the monetary policy discussions of 26 April and the current discussions on 24 May, the shekel strengthened against the dollar by 6.8 percent, and against the euro by 1.9 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 strengthened by 0.6 percent. Over this period, the strengthening of the shekel against the dollar was consistent with the global trend of the weakening of the dollar.
   
The capital and money markets: Between the interest rate discussions of 26 April and 24 May the Tel Aviv 25 share price index rose by 11.6 percent and the Tel Aviv 100 index by 14.5 percent. In this period stock markets around the world generally recorded sharp increases. Yields on unindexed 10-year Israeli government bonds increased by about 60 basis points to 5.47 percent, and yields on US government 10-year bonds increased by about 30 basis points to 3.3 percent, so that over the period as a whole the yield gap between the Israeli bonds and US government bonds widened to 220 basis points. Yields on Israeli corporate bonds fell. The Tel-Bond 20 index increased by 0.6 percent, and the Tel-Bond 40 index by 3.8 percent. Israel's sovereign risk premium, as measured by the five-year CDS spread, declined further this month, from 1.8 percent to 1.4 percent. The CDS spreads of other countries also narrowed. In the last twelve months the M1 monetary aggregate (cash held by the public and demand deposits) has grown by 59 percent, and the M2 aggregate (M1 plus unindexed deposits up to one year) by 19 percent. The rapid increase in M1 was partly due to the public's switching from deposits to current accounts in light of the low level of interest on the deposits that are included in M2.
   
The world economy: It seems that the global crisis has entered a new phase. Concern over possible systemic collapse has eased. In the last few weeks more and more indications point to improvements in the global financial markets and the beginnings of the stabilization of economic activity. Much of the recently published economic data is not as bad as expected, and some data are in fact positive. Financial conditions are improving with the reduction in uncertainty regarding the banking sector. The economic environment remains weak, however, and the basic data still indicate that the economy is in a recession. Against the background of the persistent slowdown in world demand, and despite some rise in inflation expectations, inflation and inflation expectations are still well contained. Many central banks are continuing to implement expansionary monetary policies, and those that have not yet reached zero interest rates are making further cuts in their rates. As the interest rate in some countries is close to zero, central banks are continuing to examine alternatives to interest rate policy, and are focusing on various methods of quantitative easing and dealing with specific credit markets that have encountered difficulties. At the same time, many governments are persisting with expansionary fiscal policies in their attempts to support their economies.
   
   
The main considerations behind the decision
The decision to leave the interest rate unchanged for June 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 support the achievement of the inflation target, real economic activity, and the stability of the financial system. The main considerations behind the decision are:
   
  Inflation expectations in Israel for the next twelve months, both those of the forecasters and those derived from the capital market, are around the midpoint of the target range.
   
  Data from the financial side, and recently also from the real side, indicate that the negative trend in economic activity may be moderating. That said, renewed growth is expected only towards the end of the year. At this stage the low interest rate together with the other tools that the Bank of Israel is operating are helping the economy return to positive growth.
   
  Central banks around the world are keeping their interest rates low, and are focusing on additional monetary tools that they have activated; those that have not yet reached very low levels of interest are continuing to reduce their rates.
   
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––price stability, the encouragement of employment and growth, and support for the stability of the financial system.
   
   
The minutes of the discussions prior to the above interest rate decision will be published on 8 June 2009.
The decision regarding the interest rate for July 2009 will be published at 17:30 on 22 June 2009.