The Bank of Israel increases the interest rate for December 2009 by 0.25 percentage points, to 1 percent

23.11.2009
 
The Bank of Israel increases the interest rate for December 2009 by 0.25 percentage points, to 1 percent
 
The Bank of Israel announces an increase of 0.25 percentage points in the interest rate for December 2009, to 1 percent.
Background conditions
Inflation data: The Consumer Price Index (CPI) rose by 0.2 percent in October, the middle of the range of expectations of a rise of between 0.1 percent and 0.3 percent. In the last twelve months the CPI has increased by 2.9 percent, and since the beginning of the year by 3.6 percent. 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 from the beginning of the year to October was close to the midpoint of the inflation target range.
Inflation and interest rate forecasts: From the time of the last interest rate decision, inflation expectations for the next twelve months derived from the capital market increased somewhat. In the last few days they stood at 2.5 percent, the average of the capital market expectations in the month prior to the previous decision (on 26 October). The average of forecasters’ inflation expectations for the next twelve months, however, increased following the publication of the October index, from 2.4 percent to 2.6 percent. Forecasters’ expectations of the Bank of Israel interest rate are on average for an increase of 0.4 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 also for a rising trend, with the rate a year hence at 2.3 percent.
Real economic activity: National Accounts figures for the third quarter strengthen the assessment that Israel's economy is recovering from the crisis, and that the renewed growth is becoming more firmly established. The data show that GDP grew in the third quarter at an annual rate of 2.2 percent, after increasing at a rate of about 1 percent in the second quarter. The growth expresses significant recovery in all the components of demand. Private consumption increased at an annual rate of 8.9 percent, fixed investment at a rate of 23.2 percent, and exports at a rate of 21.8 percent. In addition to these impressive figures, goods and services imports surged by an exceptionally steep 61.9 percent. The 0.5 percent rise in the composite state-of-the-economy index in October reflects a steep increase in the index of exports of manufactured goods and declines in the most recent indices of the other components.
The labor market and wages: The various labor market indicators taken together suggest stabilization, but uncertainty remains regarding when the rate of unemployment will begin to decline. The trend data in the Central Bureau of Statistics Manpower Survey indicate that the unemployment rate stabilized from April to July 2009, having increased markedly since July 2008. Demand for labor increased in the third quarter of 2009, after five quarters of continuous decline, but it is still considerably lower than in the third quarter of 2008. Employment Service data for September give no clear indication of a change in the negative trend. According to National Insurance Institute data, the real wage in June–August was 2.2 percent lower than in June–August 2008, and the number of employee posts was 2.6 percent lower. Health tax revenues, which provide an up-to-date indicator of total wage payments, were stable.
Budget data: In January–October 2009 the budget deficit (excluding credit) totaled NIS 24.5 billion, compared with a balanced budget in those months in 2008. Domestic expenditure till now, however, is NIS 4.4 billion lower than the expenditure path consistent with the budget. The forecast of the budget deficit in 2009 based on performance of the budget to October is that it will be below the target of 6 percent of GDP.
The foreign exchange market: In the last month the dollar strengthened against most currencies. In the period between the monetary policy discussions of 25 October and 22 November, the shekel weakened by 3.2 percent against the dollar, by 2.2 percent against the euro, and by 2.9 percent in terms of the index of the nominal effective exchange rate vis-?-vis the currencies of Israel's trading partners (weighted by the volume of trade).
The capital and money markets: Between the monetary policy discussions of 25 October and 22 November, the Tel Aviv 25 index rose by 1.4 percent, and the Tel Aviv 100 index by 1.5 percent. The leading stock exchanges around the world also recorded share price increases. The positive trend in the government bond market continued this month. Yields on unindexed 10-year Israeli government bonds declined by 0.16 percentage points, and yields on 10-year US government bonds fell by 0.13 percentage points, to 3.36 percent, so that the yield gap between Israeli and US unindexed government bonds remained almost unchanged at 1.5 percentage points. Over the above period, yields on makam increased––the yield on twelve-month makam increased by 0.1 percentage points, and is currently 1.6 percent. The Tel-Bond 20 index increased in the period by 1.3 percent, and the Tel-Bond 40 index by 2.7 percent. Israel's sovereign risk premium, as measured by the five-year CDS spread, increased slightly, in line with the global trend in CDS spreads.
The money supply: Following the decline in September, the M1 monetary aggregate (cash held by the public and demand deposits) fell in October by 1 percent. The M2 aggregate (M1 plus unindexed deposits up to one year) fell by 0.1 percent.
The world economy: The recovery process continued. In the third quarter of 2009, following declines in the previous quarters, GDP grew in the US by 3.5 percent (annual rate), in the eurozone by 1.7 percent, and in Japan by 4.8 percent. Unemployment, however, continued to increase in the US and the eurozone. In the UK, GDP contracted again in the third quarter. The emerging market economies, mainly in Asia and South America, are showing rapid growth rates, led by China with an impressive 8.9 percent growth rate in the third quarter. Assessments are that rapid growth will continue in the coming quarters. Recovery is also visible in world trade. In the next few quarters growth in the Western economies is expected to be due mainly to the government support programs and the recovery of the business sector. Globally, inflation continues to be low, but at the same time fears of deflation are abating. The Fed and the ECB are starting to take steps indicating a gradual withdrawal from the non-conventional aspects of monetary policy. In some countries where the recovery has become more firmly established interest rates have been increased. Capital markets around the world recorded increases during most of the last month, following relatively steep drops at the beginning of the month. This took place against the background of the G-20 meeting in early November, in which the members agreed to maintain support until the recovery is assured, together with positive third-quarter results reported by companies and the continued improvement in economic activity.
The main considerations behind the decision
  Inflation measured over the previous twelve months was 2.9 percent, and in the coming months is expected to be above the upper limit of the target range, although this is largely attributable to the effects of increases in tax rates and government controlled prices. However, one-year-forward inflation expectations increased moderately last month, and are in the upper part of the target range, even though they incorporate expectations of increases in the interest rate in the course of the next year.
  The decision to increase the interest rate for December by 0.25 percentage points will help to establish inflation one year ahead firmly within the target range, after the effects of the non-recurring government initiated price increases have passed.
  National Accounts data for the third quarter indicate recovery in economic activity, reflecting a significant increase in private consumption, exports and investments. The recent increase in Israel's exports is aided by the recovery of world trade.
  Interest rates of the leading central banks around the world are low, and are expected to remain so during the coming months. That said, the Fed and the ECB have started implementing steps that point to a gradual exit from the non-conventional aspects of monetary policy. In some countries where the recovery has become more firmly established interest rates have been increased.
Israel’s economic indicators point to a recovery, but uncertainty persists regarding its strength. Even after this increase, the interest rate in December will be at the low level of 1 percent, continuing the accommodative monetary policy that is intended to support further economic recovery, particularly in light of the prevailing uncertainty, as well as placing inflation firmly within the target range.
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.