The Bank of Israel increases the interest rate for January 2010

28.12.2009
 
The Bank of Israel increases the interest rate for January 2010
The Bank of Israel announces an increase of 0.25 percentage points in the interest rate for January 2010,
to 1.25 percent
 
Background conditions
Inflation data: The Consumer Price Index (CPI) rose by 0.3 percent in November, the middle of the range of forecasters' expectations. Over the past twelve months, the CPI has risen by 3.8 percent, of which 1.2 percentage points can be attributed to the price increases resulting from changes in tax rates and surcharges, so that inflation in the last twelve months excluding those factors was 2.6 percent.
Inflation and interest rate forecasts: Forecasters' expectations for changes in the CPI in the next three months average +0.3 percent for December, –0.2 percent for January, and 0 percent for February. Their expectations, on average, are that inflation in 2009 will be 4.2 percent, and their expectations for the next twelve months average 2.7 percent. Inflation expectations for the next twelve months derived from the capital market have averaged 2.5 percent since the last interest rate decision. Forecasters’ expectations of the Bank of Israel interest rate are on average for an increase of 0.1 percentage points in the rate for January, and for a rate of 2.8 percent in a year’s time. Interest rate expectations derived from the capital market are that the rate a year hence will be 3 percent.
Real economic activity: According to most indicators, economic activity continues to expand. Initial findings from the Bank of Israel's Companies Survey for the fourth quarter suggest that the overall net balance for the business sector was positive, after five quarters of negative (or not statistically significant positive) net balances. The composite state-of-the-economy index for November rose by 0.6 percent, due mainly to an increase in manufacturing production, trade and services revenue and goods imports (imports of production inputs and consumer goods). Goods and services exports, however, declined, following their steep increase in October. The rise in the overall index this month is the eighth consecutive one, providing evidence of the continued improvement in economic activity.
The labor market and wages: The various labor market indicators taken together suggest an improvement. Initial indications from the Central Bureau of Statistics Manpower Survey for the third quarter indicate that the unemployment rate declined to 7.8 percent, from 8 percent in the second quarter. Initial data from the Ministry of Industry, Trade and Labor Employers Survey for the fourth quarter point to a marked improvement in the balance of employment (vacancies filled minus terminations of employment): for the first time in a year there was a positive balance of 23,200 posts, compared with a negative balance of 6,200 in the third quarter. According to National Insurance Institute data, the real wage in the third quarter was 0.3 percent lower than in the second quarter, while the nominal wage increased by 1.6 percent. The upward trend in health tax revenues evident since July continued and even steepened in October.
Budget data: Assuming full expenditure of the budget in 2009, the deficit is expected to be about 5 percent of GDP, about one percentage point lower than the deficit ceiling set by law.
The foreign exchange market: In the last month the dollar strengthened against most currencies, as it did in the previous month. In the period between the monetary policy discussions of 22 November and 27 December, the shekel strengthened by 0.3 percent against the dollar, by 3.7 percent against the euro, and by 2.1 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 22 November and 27 December, the Tel Aviv 25 index rose by 6.4 percent, and the Tel Aviv 100 index by 6.1 percent. The leading stock exchanges around the world also recorded share price increases. Following the downgrade of the credit ratings of several countries, the yield on government bonds increased this month. Yields on unindexed 10-year Israeli government bonds increased by about 40 basis points (b.p.), and yields on 10-year US government bonds by 60 b.p., to 3.84 percent, so that the yield gap between Israeli and US unindexed government bonds narrowed to 143 b.p. Over the above period, yields on makam increased––the yield on twelve-month makam increased by 30 b.p., and is currently 1.94 percent. The Tel-Bond 20 index declined in the period by 2.2 percent, and the Tel-Bond 40 index by 1.8 percent. Israel's sovereign risk premium, as measured by the five-year CDS spread, increased by 14 b.p. to 1.31 percent, following the downgrading of Greece's credit rating, but in the last few days it declined again to 1.24 percent..
The money supply: After declining by 1.7 percent in October, the M1 monetary aggregate (cash held by the public and demand deposits) increased in November by 0.8 percent. The M2 aggregate (M1 plus unindexed deposits up to one year) fell by 0.5 percent in November, continuing the decline of the last few months.
The world economy: Macroeconomic data generally continued to paint a positive picture this month: improvements were recorded with regard to labor markets, production and growth in economies around the world, as well as the start of the process of replenishing stocks. Against this background, the growth forecasts of many countries were revised upwards. Some of the growth, however, was based on the significant fiscal expansion that among other things incurred increased government debt. With the easing of the crisis, there is increased concern over the debt repayment ability of several countries, and this led to reductions in their credit ratings and rating outlooks. The press releases relating to the Fed interest rate decision explained its strategy for exiting from the unconventional aspects of its accommodative monetary policy during the crisis. The exit will apparently be passive, and will be expressed by the non-renewal of auction facilities when they expire. In the UK, however, an increase in asset purchases was announced. In Australia and Norway, which were affected relatively slightly by the crisis, the central banks increased the rate of interest again this month. Despite signs of economic recovery and some increase in inflation expectations, the major central banks continue to expect that inflation will remain moderate, in light of wide output gaps. In some countries, for example Japan, there is concern over deflation. However, rising food prices cause concern regarding inflation in the emerging market economies.
The main considerations behind the decision
The decision to increase the interest rate for January was taken in light of the inflation environment in Israel which is in the upper part of the price stability range, against the background of growth that is becoming more firmly based and the increase in prices of assets, including housing. Nevertheless, even after this increase in the interest rate, monetary policy continues to be expansionary. This increase in the interest rate is part of a gradual process of returning interest to a "normal" level; the path of the return will be determined in accordance with the degree of firmness of growth, both global and in Israel, the rate at which the major central banks increase their interest rates, and the inflation environment.
  Inflation measured over the previous twelve months was 3.8 percent, and excluding the effects of increases in taxes and in government controlled prices, it was 2.6 percent. One-year-forward inflation expectations are slightly below the upper limit of the target range; these are accompanied by expectations of increases in the interest rate next year.
  Recent economic indicators in Israel show that the economy is firmly on the path out of the recession. Thus, initial indications from the Companies Survey show increased activity; Manpower Survey data point to some decline in unemployment; it can be seen from foreign trade data that manufacturing exports are on a rising trend; and manufacturing production and revenue data also show an improvement. The global economy is also exhibiting clearer signs of recovery from the crisis, including the increase in world trade. Uncertainty persists, however, regarding the rate of recovery of the global economy, a factor that contributes to uncertainty about Israel's economic recovery.
  Interest rates of the leading central banks around the world are low, and are expected to remain so during the coming months, alongside a gradual exit from the non-conventional aspects of their expansionary monetary policies. An increase in the rate of interest by the Bank of Israel is likely to have some effect on the exchange rate of the shekel against other currencies.
The Bank of Israel will continue to monitor Israeli and worldwide economic and financial 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.