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

26.10.2009
 
The Bank of Israel leaves the interest rate for November 2009 unchanged
 
The Bank of Israel announces that the interest rate for November 2009 will be unchanged at 0.75 percent.
Background conditions
Inflation data: The Consumer Price Index (CPI) fell by 0.3 percent in August, below the range of expectations of between –0.2 percent and +0.2 percent. In the last twelve months the CPI has increased by 2.8 percent, and since the beginning of the year by 3.4 percent. However, excluding the effects of seasonality and the price increases resulting from changes in tax rates and surcharges (the increase in tax on cigarettes and fuel, VAT, and the water surcharge), the annual rate of inflation since the beginning of the year is around the midpoint of the inflation target range.
Inflation and interest rate forecasts: Inflation expectations did not change significantly during the last month. Expectations for the next twelve months derived from the capital market remained stable at about 2.3 percent. The average of forecasters’ inflation expectations for 2009 increased slightly, to 3.7 percent, and for the next twelve months, to 2.4 percent. Forecasters’ expectations of the Bank of Israel interest rate are on average for an increase of 0.2 percentage points in the next three months, and for a rate of 2.6 percent in a year’s time. Interest rate expectations derived from the capital market are for a rising trend, with the interest rate a year hence at 2.4 percent.
Real economic activity: The positive signs of a turnaround in real economic activity persist, with a gradual economic recovery evident. The Companies Survey for the third quarter confirms this assessment. The overall net balance reported in the survey was positive for the first time since the second quarter of 2008. The composite state-of-the-economy index rose by 1.2 percent in September, its fourth successive rise. The rise resulted from increases in the indices of manufacturing production, trade and services revenue, services exports, and imports, while the index of goods exports declined.
The labor market and wages: Labor market indicators reflect the uncertainty about the direction and strength of changes in the market, but taken together they suggest that it is stabilizing. Health tax revenues, which provide an up-to-date indicator of total wage payments, continued to increase in September for the third month in a row, and at a faster rate. In the months May–July the number of employee posts increased, and according to Employment Service data the number of work-seekers dropped. The unemployment rate based on the Central Bureau of Statistics trend estimates declined for the third consecutive month, and in August reached 7.6 percent. It should be noted, however, that the trend data figures tend to be revised. The real wage in May–July 2009 was 3.3 percent lower than that in May–July 2008, and the nominal wage, 0.1 percent lower.
Budget data: In January–September 2009 the budget deficit (excluding credit) totaled NIS 21.9 billion, in contrast to a budget surplus of NIS 1.3 billion in those months in 2008. The forecast of the budget deficit in 2009 based on performance of the budget to date is that it will be below the target of 6 percent of GDP. Tax revenues have been recovering since July, and for the year 2009 are expected to exceed the budget forecast by 2.7 percent. In September the government approved a reallocation of budgetary expenditure, to finance non-recurring outlays by the Ministries of Defense and Health.
The foreign exchange market: In the last month the dollar again weakened against most currencies. In the period between the monetary policy discussions of 23 September and 25 October, the shekel strengthened by 1.1 percent against the dollar, weakened by 0.8 percent against the euro, and remained unchanged 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 strengthening of the shekel against the dollar was not very different from the performance of other currencies vis-?-vis the dollar, with a significant number of the major currencies strengthening by more than did the shekel. The Bank of Israel’s activity in the forex market served to moderate the strengthening of the shekel against the dollar.
The capital and money markets: Between the monetary policy discussions of 23 September and 25 October, the Tel Aviv 25 and the Tel Aviv 100 indices both rose by about 5.5 percent. Most leading stock exchanges around the world also recorded share price increases. The positive trend in the government bond market continued this month. Over the above period, yields on makam declined––the yield on makam of up to a year fell by 0.2 percentage points, and is currently 1.48 percent. Yields on unindexed 10-year Israeli government bonds declined by 0.1 percentage points. Yields on 10-year US government bonds increased by 0.07 percentage points, to 3.49 percent, so that the yield gap between Israeli unindexed bonds and the US bonds contracted, to 1.5 percentage points. In the period between the previous and the current interest rate discussions, the Tel-Bond 20 index increased by 2.3 percent, and the Tel-Bond 40 index by 2.7 percent. Israel's sovereign risk premium, as measured by the five-year CDS spread, declined in line with the global trend in CDS spreads.
The money supply: The M1 monetary aggregate (cash held by the public and demand deposits) fell in September by 1.2 percent, its first fall in a year, whereas the M2 aggregate (M1 plus unindexed deposits up to one year) increased by 0.7 percent.
The world economy: Most of the economic data published last month point to the stabilization of economic activity or beginnings of economic growth in the advanced economies, more rapid recovery in Asia, and growth in global manufacturing and world trade. Nonetheless, the international institutions assess that the recovery in the global economy will be slow and lengthy, and economic activity is currently below the pre-crisis level. The IMF stated this month that the global economy was emerging from the recession, and thus revised its growth forecast upwards, with a smaller global contraction of 1.1 percent in 2009, and higher positive growth of 3.1 percent in 2010. Inflation is low in most countries, and forecasts are that it will continue thus in the near future. Against this background, economic policy in most countries is expected to remain expansionary in the next few months.
The main considerations behind the decision
The decision to keep the interest rate for November unchanged at 0.75 percent will help keep inflation 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 was 2.8 percent. Inflation from the beginning of the year, however, excluding the effects of increased tax rates and surcharges and seasonally adjusted, was 1.9 percent at an annual rate, practically the middle of the target range. Inflation expectations for the next twelve months, both those of the forecasters and those derived from the capital market, remained this month at just above the midpoint of the target range. The existence of an output gap, the expectation that it will continue in 2010 despite the incipient recovery in economic activity, and the fact that the short-term effects of the government-initiated price increases will come to an end, will all act to moderate inflation over the next year.
  The economic indicators show continued recovery in economic activity in Israel. Nevertheless, there is still uncertainty regarding the strength of the recovery in Israel, mainly because of the uncertainty about the recovery in the global economy. World trade declined in August, after increasing in the previous months; the level of activity in the US, one of Israel's main export markets, remains low; unemployment is still high in the advanced economies, and also in Israel unemployment is still above the full employment level; budget deficits and public debt in the major economies after the crisis are high, and give rise to uncertainty about the rate of recovery in those countries.
  Interest rates of the leading central banks around the world are low, and are expected to remain unchanged during the coming months.
The Bank of Israel’s decision to keep the interest rate for November unchanged and to continue with an expansionary monetary policy and with its foreign exchange market policy strikes a balance between maintaining price stability, supporting the recovery of the economy and boosting employment in light of the high unemployment rate, and preserving 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.