The Bank of Israel leaves the interest rate unchanged for August 2009, and is ending its program of purchasing government bonds

27.7.2009
 
The Bank of Israel leaves the interest rate unchanged for August 2009,
and is ending its program of purchasing government bonds
 
The Bank of Israel announces that the interest rate for August 2009 will remain unchanged at 0.5 percent, and that on 5 August 2009 it will end its program of buying government bonds.
Background conditions
Inflation data: The Consumer Price Index (CPI) rose by 0.9 percent in June, exceeding the forecasters' expectations of a rise of between 0.3 percent and 0.5 percent. Since the beginning of 2009 the CPI has risen by 2.1 percent, mainly due to housing and energy prices, which increased by 2.8 percent and 8.1 percent respectively. The index excluding housing and energy rose by 1.3 percent since the beginning of the year. The inflation rate measured over the previous twelve months was 3.6 percent.
Inflation and interest rate forecasts: Before the publication of the June CPI, the average of forecasters' inflation expectations twelve months forward was 2.5 percent, and expectations derived from the capital market were 2.0 percent; after the publication of the June index, these increased to 2.8 percent and 2.6 percent respectively. In the next two months the increase in the CPI is expected to be high, in part due to price increases expected to result from the changes in tax rates and government-supervised prices. The averages of forecasters' expectations are for an increase of 0.8 percent in July and 0.5 percent in August. Based on these predictions, inflation measured over the previous twelve months is expected to remain close to the upper limit of the target inflation range for most of the next twelve months. As inflation expectations increased following the publication of the June CPI, both of the forecasters and those calculated from the capital market, so did forecasts of the Bank of Israel interest rate. Although no change in the interest rate is expected for August, the average of forecaster's and capital market expectations of the Bank of Israel interest rate at the end of 2009 is about 1 percent, and in a year's time, about 2 percent.
Real economic activity: Indicators and data that became available during the last month support the assessment that the decline in real activity slowed or even halted in the second quarter. The Bank of Israel's Companies Survey for the second quarter of 2009 indicates a net negative balance, but a significant improvement compared with the first quarter: –11 percent in the second quarter, compared with –41 percent in the first. The Bank of Israel's composite state-of-the-economy index rose by 0.2 percent in June, its first rise in about a year. The composite index for June was affected by positive foreign trade data. The purchasing managers index crossed the 50 percent line for the first time in one-and-a-half years. The increases in indices of consumer confidence in the last two months were followed by another increase this month. In June the trend of moderation in the rate of decline in both direct and indirect tax revenues that started in March 2009 continued. On the other hand, the leading index in the Companies Survey shows expectations of a further decline in activity in the third quarter, albeit a far more moderate one than that reported in the previous quarter, and it is important to note that several sectors expect growth to begin in the third quarter.
The labor market and wages: The employers survey for the second quarter shows a further fall in the demand for workers, but a more moderate one than in the previous quarter. The rate of unemployment, according to the Central Bureau of Statistics trend data, continued to increase in May, and reached 8.4 percent. The real wage in the three months February–April increased by 0.7 percent compared with the previous three months, and the nominal wage by 2.7 percent (annual rates, seasonally adjusted). Health Tax revenues in May and June were 1.7 percent lower than in May and June 2008, and 2.2 percent lower than in February and March 2009 (annual rates, seasonally adjusted), suggesting a continued fall in wages and/or employment.
Budget data: In the first half of 2009 the budget deficit (excluding credit) totaled NIS 17.7 billion, in contrast to large budget surpluses in the first half of the years 2006–08. The large deficit was due mainly to the steep drop in tax revenues that started in the middle of 2008. After deducting the effect of tax rate changes and one-off receipts, tax revenues in the first half of the year were 11.7 percent lower, in real terms, than in the first half of 2008.
The foreign exchange market: In the period between the monetary policy discussions of 21 June and 26 July, the shekel strengthened by 2.2 percent against the dollar, and by 0.3 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 0.9 percent. The strengthening of the shekel derived mainly from the weakening of the dollar around the world, and was supported by the positive indicators relating to Israel's economy published during the month, and the June CPI, which exceeded expectations.
The capital and money markets: Between 21 June and 26 July the Tel Aviv 25 share price index and the Tel Aviv 100 index rose by about 11 percent, and reached their September 2008 levels, i.e., before the deterioration in the crisis. Most leading share price indices around the world also showed upward trends. Yields on unindexed 10-year Israeli government bonds declined by 11 basis points to 5.4 percent, and yields on US government 10-year bonds fell by a similar amount to 3.66 percent, so that over the period the yield gap between Israeli government bonds and US government bonds hardly changed, and remained at about 1.7 percentage points. In the corporate bond market, prices increased and yields fell. The Tel-Bond 20 index increased by 1.5 percent, and the Tel-Bond 40 index by 2.6 percent. Israel's sovereign risk premium, as measured by the five-year CDS spread, remained unchanged this month. The CDS spreads of many other countries contracted slightly.
The money supply: In the last twelve months the M1 monetary aggregate (cash held by the public and demand deposits) has grown by 56 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 rate of increase of the M1 aggregate has slowed in the last two months.
The world economy: Data indicating that the global recession is approaching its end continued to accumulate this month. The financial reporting season, which started on a positive note, together with encouraging macroeconomic data, strengthened the optimistic assessments regarding the end of the recession. Central bank and government expansionary policies around the world became more cautious: the pace of interest rate reductions slowed, and there were hints that the use of unusual steps was drawing to a close. Nevertheless, in the closing announcement of the G8 conference, the participants declared that the global economic situation did not yet justify reducing the existing programs introduced to deal with the crisis. The stabilization of commodity and energy prices, and the assessment that they would not continue to rise steeply, on the one hand, and the reduced level of concern regarding the persistence of the deep recession, on the other, were expressed in most leading economies by moderate inflation expectations. In the last two weeks the financial markets witnessed a steep increase in share and corporate bond prices.
The main considerations behind the decision
The decision to leave the interest rate unchanged for August at its current low level, and to continue foreign currency purchases, together with the decision to stop purchasing government bonds, will help strengthen the economy’s ability to cope with the effects of the global economic crisis. The main considerations behind the decisions are:
  Following the high June CPI, inflation over the previous twelve months reached 3.6 percent, and one-year forward inflation expectations are close to the upper limit of the target inflation range. The increases in the CPI are expected to be high in the next two months too, mainly because of the increases in VAT and government-supervised prices. Nonetheless, the output gap and unemployment constitute forces that will moderate price increases thereafter.
  Data and indicators from surveys on real activity in Israel obtained this month strengthen the assessment that the reduction in GDP is moderating and may actually have ended. That said, in light of the uncertainty regarding developments in the global economy it is too early to determine whether this represents a turning point. In addition, the rapid improvement in the financial markets contributes to the recovery of economic activity.
  Many central banks around the world are keeping their interest rates low and are continuing to operate the additional monetary instruments they introduced.
In this situation, the Bank of Israel's decision to keep the interest rate unchanged for August and to end the program of bond purchases as planned strikes a balance between the pressures raising prices, which are expected to moderate following the expected one-off price increases, and the assessment that the economy has not yet emerged from the recession.
The Bank of Israel will stop buying government bonds on the secondary market on 5 August 2009, and hereby announces that it does not intend to sell the securities it purchased. It notes that open-market activity (buying, selling, central bank lending of government securities) is an important central bank instrument in implementing its monetary policy. The view in the Bank of Israel is that the purchases of bonds that the Bank started on 25 March 2009 helped the capital market to return to more normal functioning, particularly with regard to the renewal of issues and raising capital by the business sector.
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 10 August 2009.
The decision regarding the interest rate for September 2009 will be published at 17:30 on 24 August 2009.