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

22.02.2010
 
The Bank of Israel keeps the interest rate for March 2010 unchanged
 
The Bank of Israel announces that the interest rate for March 2010 will be unchanged at 1.25 percent.
Background conditions
Inflation data: The 0.7 percent decline in the CPI for January was lower than expected––the forecasts had predicted a decline of between 0.3 percent and 0.5 percent, and it followed a surprisingly low December index. The low January index was mainly due to price reductions resulting from government decisions, i.e., a reduction in VAT and the cancellation of the water surcharge, and also to the decline, for the second consecutive month, in the housing index. Excluding the effects of the government actions, the January CPI declined by 0.2 percent, slightly above the seasonal path consistent with the inflation target. In the last twelve months prices rose by 3.8 percent, and excluding the effects of government measures, 3.2 percent.
Inflation and interest rate forecasts: Inflation expectations for the next twelve months derived from the capital market declined following the publication of the index for January, and currently stand at 2.4 percent. Forecasters' inflation expectations derived from the expectations of the indices of the next twelve months (February 2010 to January 2011) averaged 2.2 percent; the forecasters predict that inflation in 2010 will be 1.7 percent, and that in the next few months inflation measured over the previous twelve months will return to within the target range. With regard to the Bank of Israel interest rate, expectations of forecasters and those derived from the capital market are that it will remain unchanged for March. The forecasters predict on average that in a year's time it will be 2.75 percent, and the capital market reflects the assessment that it will be 2.6 percent.
Real economic activity: The positive trend in economic activity in Israel continued. National Accounts figures for the last quarter of 2009 show that GDP grew at an annual rate of 4.4 percent, with a similar increase in private consumption and notable expansion of goods and services exports. Fixed investment, however, dropped by 9.4 percent, and nonresidential investment by 15 percent. Growth in 2009 was 0.5 percent. The Bank of Israel composite state-of-the-economy index rose by 0.2 percent in January, and the rises in the December and November indices were both adjusted downwards from 0.4 percent to 0.3 percent. The rise in the January index was due to increases in manufacturing production and trade and services revenue. Currently, Israel's growth is being powered by private consumption and by exports, so that its rate and its stability depend to a great degree also on the strength of global growth.
The labor market and wages: According to National Insurance Institute (NII) data, the number of Israeli employee posts remained unchanged in November, after increasing in each of the preceding three months. The trend data, however, show that the increase in the number of employee posts that started in June 2009 continued in November. NII data on the wage per employee post in September–November show a 0.7 percent increase in the nominal wage, meaning a 2.5 percent decline, year on year, in the real wage. Health tax revenues in December indicate that the positive trend in total wage payments that started in July 2009 continued.
Budget data: The domestic budget surplus in January, excluding credit, was NIS 4 billion, compared with a surplus of NIS 1.4 billion in January 2009. The surplus this month is NIS 2.8 billion higher than the seasonal surplus consistent with meeting the budget deficit ceiling of 5.5 percent of GDP. The deviation from the seasonal path reflects the continued acceleration in tax revenues. Thus the positive trend in the budget deficit trend that started in November is continuing. That said, the surplus is still low compared with those in the years from 2005 to 2008.
The foreign exchange market: In the period between the previous monetary policy discussions of January 24 and February 21, the shekel depreciated by 0.9 percent against the dollar, and appreciated by 3.7 percent against the euro, against the background of the dollar's recent strengthening against the euro. 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 shekel appreciated by 1.26 percent between January 24 and February 18.
The capital and money markets: Between the monetary policy discussions of January 24 and February 21, the Tel Aviv 25 index rose by 3.9 percent, and the Tel Aviv 100 index by 3.6 percent. This was similar to the trend in the major stock exchanges. Government bonds showed a positive trend, in contrast to the trends in most emerging market countries. Over the month, yields on unindexed 10-year shekel bonds fell by 4 basis points (b.p.), and yields on 10-year indexed bonds fell by about 2 b.p. As yields on 10-year US government bonds increased by about 18.5 b.p., to 3.77 percent, the yield gap between Israeli and US unindexed government bonds contracted significantly, to about 120 b.p. The yield to maturity on twelve-month makam was stable at about 1.9 percent. The positive trend in the Tel-Bond indices persisted, with the Tel-Bond 20 index rising by 0.8 percent, and the Tel-Bond 40 index by 2.3 percent. Israel's sovereign risk premium, as measured by the five-year CDS spread, held steady at 1.24 percent, in contrast to steep increases in CDS spreads of most emerging and advanced economies..
The money supply: The M1 monetary aggregate (cash held by the public and demand deposits) decreased by 2.3 percent in January, following its decline of 0.4 percent in December. The M2 aggregate (M1 plus unindexed deposits up to one year) increased by 0.3 percent in January, after increasing by 0.5 percent in December.
The world economy: The global economy continued its recovery from the crisis, as could be seen from the positive growth figures of the US and China for the last quarter of 2009. The IMF revised its global growth forecasts upwards. In light of weak employment figures in the G3 countries, however, there remains the risk of another recession, whose probability may even have increased. The debt problems in some European countries and concern over the possibility of another recession led to a situation in which the markets indicate assessments that the transition to a tighter monetary policy will be delayed in some countries, and expectations of increases in the interest rates of the major central banks have been pushed back. Nevertheless, the Fed approved the increase of the discount window rate from 1/2 percent to 3/4 percent, another step in the process that started a few months ago of reducing and ending the Fed's various support programs. In its announcement of the increase, the Fed explained that this did not signal any change in monetary policy, and that the federal funds reserve rate was likely to remain exceptionally low for an extended period. Inflation in the advanced economies continues to be low, against the background of large output gap in the global economy.
The main considerations behind the decision
The decision to keep the interest rate for March unchanged at 1.25 percent is part of the gradual process of returning interest to a more "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 entrenchment of growth, both global and in Israel, the rate at which the major central banks increase their interest rates, and in light of developments in the exchange rates of the shekel.
  The January CPI was the second successive surprisingly low index, with the two indices cumulatively more than half a percentage point lower than expected. Inflation expectations for the next twelve months calculated from the capital market, and forecasters' twelve-month inflation expectations are within the target inflation range, at 2.4 percent and 2.2 percent respectively. The assessments are that in the next few months, inflation measured over the previous twelve months will come back into the target range, in part reflecting the effect of the recent appreciation of the shekel, the reduction in VAT and the cancellation of the water surcharge.
  Recent economic activity is continuing to develop positively. Various risk factors, however, still cast a shadow over the positive global growth trends.
  Interest rates of the leading central banks around the world are very low, and are expected to remain so during the coming months. Nonetheless, some leading central banks are reducing their use of special instruments of monetary accommodation.
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 March 2010.
The decision regarding the interest rate for April 2010 will be published at 17:30 on Sunday, 28 March 2010 (instead of the scheduled Monday 29 March, because of the Passover holiday).