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

24.9.2009
 
The Bank of Israel leaves the interest rate for October 2009 unchanged
 
The Bank of Israel announces that the interest rate for October 2009 will be unchanged at 0.75 percent.
Background conditions
Inflation data: The Consumer Price Index (CPI) rose by 0.5 percent in August, in line with the forecasters' expectations. Over the last twelve months the CPI has increased by 3.1 percent, and since the beginning of the year by 3.7 percent. Excluding the effects of seasonality and the price increases resulting from changes in tax rates (the increase in tax on cigarettes and fuel, VAT, and the water surcharge), the rate of inflation since the beginning of the year has been around the midpoint of the inflation target range.
Inflation and interest rate forecasts: Inflation expectations, which fell below the midpoint of the inflation target range at the end of August, rose again at the beginning of September, and the average of expectations for the next twelve months––both of forecasters and those derived from the capital market––is 2.3 percent. The average of forecasters’ inflation expectations for September is for a decline of a tenth of a percentage point, and for October, for an increase of two tenths of a percentage point. According to these forecasts, inflation measured over the previous twelve months is expected to remain around the upper limit of the target range in the next two months. Expectations of the Bank of Israel interest rate derived from the capital market are for a rising trend in the next few months, with the interest rate a year hence at 2.4 percent. Forecasters’ expectations of the interest rate are on average for an increase of 0.1 percentage points in the rate for October, and for a rate of 2.8 percent in a year’s time.
Real economic activity: The latest available data indicate that the recovery in activity has continued. At the end of August the Bank of Israel revised its forecasts of growth in 2009 and 2010 upwards: it changed its forecast for 2009 from a reduction of 1.5 percent in GDP to one of stability, and it raised its previous forecast of 1 percent growth in 2010 to one of 2.5 percent growth.
The August composite index of the state of the economy increased by 1.3 percent, following increases in the index for July and also in the indices for May and June. It should be noted, however, that the rise in the index reflects mainly increases in goods and services exports, while manufacturing production and trade and services revenue registered declines in July. Initial findings from the Bank of Israel Companies Survey for the third quarter also indicate a recovery in activity, i.e., a positive net balance, for the first time since the second quarter of 2008.
The labor market and wages: The Manpower Survey for the second quarter of 2009 shows further deterioration in the labor market in that quarter, albeit a more moderate decline than in the previous quarters. The unemployment rate increased by 0.4 percentage points, to 8 percent, a lower figure than had been anticipated. Although unemployment has increased in the current crisis, it has not risen to the levels it reached in the recession of 2001–03. The real wage in April–June 2009 was 3.6 percent lower than in April–June 2008, and the nominal wage was 0.6 percent lower than in those months in 2008. By contrast, data on Health Tax revenues in July point to an increase in total wage payments, further to the increase recorded in June.
Budget data: In January–August 2009 the budget deficit (excluding credit) totaled NIS 19.4 billion, in contrast to a budget surplus of NIS 1.5 billion in those months in 2008. The forecast of the budget deficit in 2009 based on performance of the budget from January to August is that the deficit will be slightly below the target of 6 percent of GDP. In August direct tax revenues stabilized, following a long period of decline. Indirect tax revenues have shown a moderate upward trend since April this year.
The foreign exchange market: In the period between the monetary policy discussions of 23 August and 23 September, the shekel strengthened by 2.26 percent against the dollar, and weakened by 1.1 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 0.46 percent. The strengthening of the shekel against the dollar was not very different from the performance of other currencies vis-?-vis the dollar, some of which strengthened by more than did the shekel. The reasons for the strengthening of the shekel include the surplus in the current account of the balance of payments and the increase last month in the Bank of Israel interest rate. The Bank’s activity in the forex market served to moderate the exchange rate appreciation.
The capital and money markets: Between the monetary policy discussions of 23 August and 23 September, the Tel Aviv 25 and the Tel Aviv 100 indices rose by about 0.6 percent, despite the fact that announcements by companies that they were unable to repay their debts cast a shadow over the share and corporate bond markets during most of the period. Most leading share price indices around the world showed stronger increases. In the government bond market, yields dropped during most of the period, with significant reductions of between 20 and 45 basis points along the entire curve in the unindexed local-currency segment. The indexed segment followed a similar path, with drops of between 10 and 30 basis points along the whole curve, with the short part of the curve showing the greatest declines. The makam yield curve, however, showed yield increases of 15–30 basis points over the entire curve, with the yield on one year makam at about 1.7 percent. The yield gap between 10-year unindexed Israeli government bonds and US government bonds stayed almost unchanged, at 1.70 percentage points. In the corporate bond market prices fell sharply, the first decline in several months (following companies’ announcements mentioned above, that they were unable to meet their debt repayments), but in the last few days prices increased again. In the period between the previous and the current interest rate discussions, the Tel-Bond 20 index increased by 1.39 percent, while the Tel-Bond 40 index dropped by 1.6 percent. This month new bond issues totaled about NIS 4 billion, and since the beginning of the year, about NIS 30 billion, compared with about NIS 22 billion in the whole of 2008. Israel's sovereign risk premium, as measured by the five-year CDS spread, declined from 1.15 percentage points to 1 percentage point this month, in line with the global trend in CDS spreads.
The money supply: The rate of increase in the M1 monetary aggregate (cash held by the public and demand deposits) over the last twelve months reached 64 percent in August, compared with 56 percent in July, and the M2 aggregate (M1 plus unindexed deposits up to one year) increased by 20 percent in the twelve months to August, similar to the rate in the twelve months to July. This reflects the continued process of adjusting the components of the money supply to the low interest environment. That said, it is too early to assess the effect of the increase in the interest rate last month on the development of the monetary aggregates.
The world economy: One year after the collapse of Lehman Brothers, there are more and more signs that the global economy is recovering from the crisis and is returning to a path of growth. This month too the positive trend that appeared in March persisted. World trade increased by 2.5 percent (monthly figure) in June, and this month the IMF revised its forecast of world growth upward. There is still concern, however, that in some sectors the crisis has not ended, particularly in the financial sector. The investment houses expect inflation of 1.5 percent in 2009 and 2.5 percent in 2010, but there is still concern regarding deflation in the US, Europe, and in particular, in Japan. The leading central banks are continuing with their expansionary monetary policies. In summary, global financial and economic conditions are continuing to improve.
The main considerations behind the decision
The decision to keep the interest rate for October unchanged at 0.75 percent will help return inflation to within the target range and underpin the recovery in real activity, while supporting financial stability. The main considerations behind the decision are:
  Inflation measured over the previous twelve months is slightly above the target range. Inflation from the beginning of the year, however, excluding the effects of increased tax rates and seasonally adjusted, is at the midpoint of the target range. Inflation expectations for the next twelve months, both those of the forecasters and those derived from the capital market, are also at around the midpoint of the target range. The rate of inflation is expected to return to within the target range when the short-term effects of the increases in taxation have run their course. The appreciation of the shekel in terms of the nominal effective exchange rate in the last few months contributed to the moderation of inflation.
  The continued recovery in economic activity and the expectation of faster growth in Israel and world wide suggest that the current environment is one of recovery from the recession. That said, the low rate of GDP growth in the last three quarters has resulted in an output gap that is reflected in a high rate of unemployment, that also serves to dampen inflationary pressures. In addition, there is uncertainty regarding the strength of the recovery in Israel, in part because of the uncertainty about the recovery in the global economy.
  Interest rates of the leading central banks around the world are low, and are expected to remain unchanged during the next few months.
The Bank of Israel’s decision to keep the interest rate for October unchanged and to continue with an expansionary monetary policy and its foreign exchange market policy strikes a balance between the need to return inflation to the target range of price stability, to continue to support the recovery in economic activity, to boost employment in light of the high unemployment rate, and to maintain financial stability.
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 12 October 2009.
The decision regarding the interest rate for November 2009 will be published at 17:30 on 26 October 2009.