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

22.6.2009
 
The Bank of Israel leaves the interest rate unchanged for July 2009
 
The Bank of Israel announces that the interest rate for July 2009 will remain unchanged at 0.5 percent.
Background conditions
Inflation data: The Consumer Price Index (CPI) rose by 0.4 percent in May, in line with the forecasters' expectations. Since the beginning of 2009 the CPI has risen by 1.2 percent. For the first time since December 2007, the inflation rate (measured over the previous twelve months) of 2.8 percent was within the target range.
Inflation and interest rate forecasts: The averages of forecasters' predictions regarding the CPI are for an increase of 0.4 percent in June and 0.6 percent in July. Following one-off price increases expected in the next two months, resulting in part from changes in tax rates and in government-supervised prices, including water prices, inflation is expected to be close to the upper limit of the inflation target range, but to decline thereafter. Twelve-month-forward inflation expectations calculated from the capital markets remained unchanged in June at their May level, 1.9 percent, close to the midpoint of the target range. Forecasters' expectations, in contrast, increased from their level of 1.9 percent in May to 2.3 percent in June. Forecasters also upped their forecasts of the Bank of Israel interest rate in mid-2010 from 1.3 percent in May to 2 percent in June, on average. The interest rate twelve months forward derived from the capital markets stood at 2.5 percent. The interest rate for July according to the average of the forecasters' predictions and that derived form the capital markets is not expected to change.
Real economic activity: Some of the data that became available during the last month support the assessment that the continued decline in real activity evident in the last quarter of 2008 and the first quarter of 2009 has moderated. Initial indications from the Companies Survey for the second quarter of 2009 point to a more moderate fall in activity: the net balance of total activity in the business sector showed a modest decline, following two quarters of steep drops. Indicators of private consumption suggest that it stabilized in the second quarter, after falling at an annual rate of about 3.5 percent in the previous two quarters. In foreign trade too there are signs of a smaller decline in imports and exports in the last two months. In the last two months the Purchasing Managers Index rose. The rate of the reduction in tax revenues eased in May, having done so also in March and April. Nonetheless, the composite state-of-the-economy index shows further decline in the level of activity: in May it fell by 0.5 percent, following its 0.7 percent drop in April and even sharper falls in the previous months.
The labor market and wages: The rate of unemployment increased for the third quarter in succession, and reached 7.6 percent in the first quarter of 2009. Unemployment trend data of the Central Bureau of Statistics gave a figure of 7.8 percent for April, and the rate is expected to continue rising in the coming quarters. The real wage and the nominal wage both increased by about 3 percent in 2009:Q1 from the level in the previous quarter (annual rate, seasonally adjusted), after three quarters in which the real wage fell. Health Tax revenues in April and May were 0.5 percent lower than in April and May 2008, and 5.2 percent lower than in February and March 2009 (annual rates, seasonally adjusted), indicating a continued fall in wages and employment.
Budget data: In the first five months of 2009 the budget deficit (excluding credit) was NIS 10.5 billion, compared with a surplus of NIS 6 billion in the first five months of 2008. The large deficit reflects the steep drop in tax revenues. In May the government continued to act without the Knesset having approved the budget. Total government expenditure in the first five months of the year was lower than the level permitted in the absence of an approved budget (monthly expenditure of one-twelfth of the previous year's budget), and was NIS 7.8 billion less than that consistent with the full implementation of the expenditure in the 2009 budget proposal.
The foreign exchange market: In the period between the monetary policy discussions of 24 May and the current discussions on 21 June, the exchange rate of the shekel against the dollar against the euro showed very little change, with 0.05 percent shekel appreciation against the dollar and 0.1 percent against the euro. 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 0.2 percent. Over this period, the shekel strengthened against the dollar more moderately than did other currencies. That said, the shekel exchange rate against the dollar and the euro was highly volatile.
The capital and money markets: Between the interest rate discussions of 24 May and 21 June the Tel Aviv 25 share price index fell by 0.6 percent while the Tel Aviv 100 index rose 1.3 percent. The downward trend of the Tel Aviv 25 index was in contrast to that in most leading share price indices around the world. Yields on unindexed 10-year Israeli government bonds edged up by 5 basis points to 5.52 percent, and yields on US government 10-year bonds increased by about 34 basis points to 3.78 percent, so that over the period as a whole the yield gap between Israeli government bonds and US government bonds narrowed to about 175 basis points. Yields on Israeli corporate bonds fell. The Tel-Bond 20 index increased by 3.3 percent, and the Tel-Bond 40 index by 6 percent. Israel's sovereign risk premium, as measured by the five-year CDS spread, increased this month, from 1.4 percent to 1.7 percent, reversing the trend of the previous few months. The CDS spreads of other countries also widened.
The money supply: In the last twelve months the M1 monetary aggregate (cash held by the public and demand deposits) has grown by 54 percent, and the M2 aggregate (M1 plus unindexed deposits up to one year) by 18 percent. The steep increase in M1 was due mainly to the public's switching from time deposits to current accounts in light of the low level of interest on the deposits that are included in M2.
The world economy: There are increasing signs that the global recession is approaching its turning point. The rate of decline has eased, and some indicators point to an improvement. The level of demand, however, is still very low, as is world trade, and there is uncertainty regarding the strength and timing of the recovery. The IMF revised its forecast of global growth in 2010 upwards from 1.9 percent to 2.4 percent, and left the forecast for 2009 at minus 1.3 percent. In the financial markets the increase in long-term bond yields was notable, a trend that was led by the US and that affected most other markets. The main reason for this was the expected increase in government bond issues to finance large budget deficits, principally in the US, but also in other countries. At the same time, the demand for government bonds has fallen because of the recovery of the financial system and increased risk tolerance on the part of investors. It seems that investors are again looking for higher yields in riskier assets, a trend that is reflected by narrowing spreads, rising indices in emerging markets, and rising share price indices and risk assets. Oil and commodity prices have increased steeply since the beginning of the year. The general view is that the resulting inflationary pressures will be offset by the wide global output gap, and that the inflation environment will remain low in 2009 and 2010. Most central banks are continuing to operate expansionary monetary policies. In countries that have not yet reached zero interest rates, further cuts in their rates are being made, and others are pursuing quantitative easing.
The main considerations behind the decision
The decision to leave the interest rate unchanged for July at its current low level, together with the complementary 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 is within the inflation target range, and forecasters' predictions as well as forecasts derived from the capital markets are that it is likely to remain within the target range in the coming year. It should be noted that changes in tax rates and in government-supervised prices in the next two months are expected to have a one-off effect on the level of prices, and thus to increase inflation (measured over the previous twelve months) to close to the upper limit of the target range. Thereafter, according to the forecasts, inflation will move closer to the midpoint of the range.
  Data on real activity in Israel strengthen the assessment that the reduction in GDP is starting to moderate. That said, real activity is expected to contract further in the next few months, with further increases in the unemployment rate. The continued expansionary monetary policy supports the return of the economy to positive growth.
  Central banks around the world are keeping their interest rates low, and continue to operate the additional monetary tools that they have activated; those that have not yet reached very low levels of interest are continuing to reduce their rates.
Expectations are for inflation in the near future to remain within the target range, even if for some time it is likely to be close to the upper limit of the range. Economic activity is expected to remain subdued in the near future. This situation provides support for keeping the interest rate at its low level in the next few months.
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 6 July 2009.
The decision regarding the interest rate for August 2009 will be published at 17:30 on 27 July 2009.