The Bank of Israel keeps the interest rate for February 2010 unchanged

25.01.2010
 
The Bank of Israel keeps the interest rate for February 2010 unchanged
 
The Bank of Israel announces that the interest rate for February 2010 will be unchanged at 1.25 percent.
Background conditions
Inflation data: After predictions of an increase of 0.3–0.4 percent, the December CPI surprised the forecasters with no change in the index, with the owner-occupied-housing component recording an unexpected decrease of 0.8 percent. Inflation in 2009 was 3.9 percent; excluding the price rises resulting from tax increases and surcharges it was 2.8 percent, within the upper part of the target inflation range.
Inflation and interest rate forecasts: Inflation expectations for the next twelve months derived from the capital market increased after the publication of the index for December, and averaged 2.7 percent in January, an increase of 0.2 of a percentage point from their level in December. Following the publication of the December index, the average of forecasters' inflation expectations for the next twelve months declined from 2.7 percent to 2.3 percent. They expect, on average, that prices will fall by a cumulative 0.3 percent in the first quarter of 2010. Forecasters’ expectations of the Bank of Israel interest rate in a year’s time are on average that it will be 2.8 percent, and expectations derived from the capital market are that it will be 2.5 percent.
Real economic activity: The latest indicators strengthen the assessment that economic activity improved substantially in the fourth quarter of 2009, with the improvement encompassing most sectors. Data from the Bank of Israel Companies Survey for that quarter indicate a marked increase in business sector activity. All industries apart from the hotel industry showed increases. The composite state-of-the-economy index rose by 0.4 percent in December, but the October index was revised downwards from a 0.6 percent increase to 0.5 percent, and the November index from 0.6 percent to 0.4 percent. In January the Bank of Israel revised its forecast of growth in Israel in 2010 upwards, from 2.5 percent to 3.5 percent, in light of the latest economic data and in light of increased forecasts of the growth in world trade. In contrast, the purchasing managers index declined in December, but is still close to the record levels it reached in the last few years. The Globes consumers confidence index also dropped in December, but it, too, remains close to its peak of the last few years. The probability of a slowdown, as measured at the Bank of Israel by the Google search index, rose slightly.
The labor market and wages: There was a significant improvement in employment in 2009:Q4. Unemployment trend data for November show a reduction in unemployment to 7.4 percent. Final figures from the Ministry of Industry, Trade and Labor Employers Survey show a sharp rise in the balance of employment (the difference between the number of positions filled and the number of terminations of employment), and currently it is positive for the first time after four consecutive quarters of a negative balance. The Companies Survey for the fourth quarter of 2009 shows that the decline in the number of employees evident in the previous quarters moderated. Health tax revenues in November indicate that the positive trend in total wage payments that started in July 2009 continued. In addition, the reduction in the number of claims for unemployment payments continued in December. National Insurance Institute data on the real wage in August–October show that it fell by 2.8 percent year on year, while the nominal wage increased by 0.1 percent.
Budget data: The total budget deficit in 2009, excluding credit, was 5.15 percent of GDP (NIS 39.3 billion), compared with 6 percent originally planned. In November and December there was a strong surge in tax revenues, particularly of indirect taxes. In those months government expenditure exceeded the seasonal expenditure path as some 2010 expenditure was brought forward. The lower-than-planned deficit was mainly the result of revenues exceeding the assessments made when the budget was drawn up.
The foreign exchange market: In the period between the previous monetary policy discussions of December 27 and January 24, the shekel strengthened by 1.7 percent against the dollar, by 3.5 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). At the beginning of the period the dollar and the euro weakened against most other currencies, and at the end of the period the dollar showed a mixed trend against the other currencies.
The capital and money markets: Between the monetary policy discussions of December 27 and January 24, the Tel Aviv 25 index fell by 1.5 percent, and the Tel Aviv 100 index by 0.3 percent. This was similar to the trend in the major stock exchanges, and was mainly due to a deterioration in investors' attitude in the last few days, reflected by their increased risk aversion and falls in the prices of riskier assets. Yields on government bonds dropped this month––yields on unindexed 10-year shekel bonds fell by 24 basis points (b.p.). As yields on 10-year US government bonds dropped by 20 b.p., to 3.61 percent, the yield gap between Israeli and US unindexed government bonds remained relatively steady at 140 b.p. Over the above period the yield on twelve-month makam was stable at 1.92 percent. The Tel-Bond 20 index rose in the period by 1.9 percent, and the Tel-Bond 40 index by 2.5 percent. Israel's sovereign risk premium, as measured by the five-year CDS spread, declined by 4 b.p. to 1.24 percent; CDS spreads around the world showed a similar trend.
The money supply: The M1 monetary aggregate (cash held by the public and demand deposits) decreased by 1.2 percent in December, following its increase of 1.2 percent in November. The M2 aggregate (M1 plus unindexed deposits up to one year) increased by 0.1 percent in December' after falling by 0.1 percent in November.
The world economy: The global economy continued its recovery from the crisis, and growth accelerated in the fourth quarter of 2009. Data published in the course of the last month indicate, however, that there are differences in the recovery rate between countries and between sectors. This is very clear in the differences between the emerging countries in Asia on the one hand, and the European and Japanese economies on the other. The weakness of private demand and the slack in the labor market continue to impair growth, especially in the advanced economies. Foreign analysts assess that the rate of growth will slow in 2010 when the effects of the various emergency measures have run their course and when steps are taken to end the rescue programs. The extent of substitution between private and public consumption when the latter is reduced constitutes one of the major causes of uncertainty with regard to growth forecasts in those countries where governments gave very significant support to deal with the crisis. Despite the recent increase in commodity and energy prices, inflation and inflation expectations in the advanced economies remained low, mainly because of the continued weakness of the labor market and the large output gap. Against this background, monetary policy is expected to continue to be expansionary, alongside a gradual exit from the special support programs, with modest increases in interest rates only after that stage. The very low level of interest rates in the major economies continues to serve as an incentive for price increases in the financial markets, and encourages the export of capital to the emerging markets.
The main considerations behind the decision
The decision to keep the interest rate for February unchanged at 1.25 percent is part of the gradual process of returning interest to a "normal" level; the process is intended to return inflation to within the target range and to contribute to the further recovery of economic activity, while supporting financial stability. The path of the interest rate will be determined in accordance with the inflation environment, the degree of firmness of growth, both global and in Israel, and the rate at which the major central banks increase their interest rates.
  The December CPI was surprisingly low, with the main surprise being the decline in the owner-occupied-housing component. The forecast is that inflation during the first quarter of 2010 will also be low, due in part to the appreciation of the shekel. Inflation expectations for 2010, those derived from the capital market (2.7 percent) and the average of forecasters' expectations (2.3 percent), are both within the target range.
  Recent economic activity is continuing to develop positively. Against this background the Bank of Israel revised its growth forecast for 2010 upwards. Recently, however, uncertainty has risen with regard to the strength of the global recovery.
  Interest rates of the leading central banks around the world are very low, and are expected to remain so during the coming months.
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 of 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 8 February 2010.
The decision regarding the interest rate for March 2010 will be published at 17:30 on 22 February 2010.