The Bank of Israel increases the interest rate for April 2010 by 25 basis points

28.03.2010
 
The Bank of Israel increases the interest rate for April 2010 by 25 basis points
 
The Bank of Israel announces that the interest rate for April 2010 will be increased by 25 basis points to 1.5 percent.
Background conditions
Inflation data: The CPI for February declined by 0.3 percent, the upper limit of the range of forecasts, which were of declines between 0.3 percent and 0.5 percent. The index was affected by the cut in electricity prices and the reduction in VAT in January. The housing component dropped for the third month in succession, giving a cumulative reduction of 1.4 percent. In the last twelve months the index rose by 3.6 percent, and excluding the effect of government actions, by 3.1 percent.
Inflation and interest rate forecasts: Forecasters expect inflation as reflected in the indices in the next twelve months (March 2010 to February 2011) to average 2.6 percent; and their expectations of inflation in 2010 average 1.8 percent. They forecast that inflation measured over the previous twelve months will return to within the target range with the publication of the April index. Inflation expectations for the next twelve months derived from the capital market remained steady, close to the upper limit of the target inflation range. With regard to the Bank of Israel interest rate, most forecasters do not expect an increase for April, but on average they expect that in a year's time it will be 2.9 percent. Expectations derived from the capital market suggest that the interest rate could increase even for April, and that in a year's time it will be 2.5 percent.
Real economic activity: Most indicators show that real economic activity continued to expand in the first quarter of 2010, but it seems likely that the rate of increase will be lower than that in the previous quarter. The continued increase in activity was reflected in the composite state-of-the-economy index for February, which rose by 0.2 percent, in domestic VAT receipts, and in various indices of activity, including the index of manufacturing production, the index of trade and services revenue, indices of consumer confidence, and the index of the probability of a slowdown calculated by the Bank of Israel Research Department based on Google search data. Initial findings of the Bank of Israel Companies Survey for the first quarter indicate continued expansion and expectations that it will continue in the next quarter. In contrast, in the last few months the increases in direct tax revenues, goods and services exports, and consumer goods imports all moderated.
The labor market and wages: Most recent data from the labor market showed continued recovery, but with differences between industries. The Manpower Survey for the fourth quarter of 2009 pointed to a further decline in the unemployment rate, to 7.4 percent. National Insurance Institute figures for the fourth quarter of 2009 indicate a 0.5 percent increase in employment compared with the previous quarter. The real wage fell by 2.2 percent compared with its level in the fourth quarter of 2008, and the nominal wage fell by 0.7 percent The upward trend in health tax receipts that started in July 2009 persisted in February, with an increase of 3.6 percent compared with February 2009 (excluding the increased revenues resulting from the doubling in August 2009 of the upper limit on wages on which employees' National Insurance payments are payable).
Budget data: The domestic budget deficit in February, excluding credit, was NIS 2.4 billion, compared with a deficit of NIS 2.7 billion in February 2009. This continues the trend following the turnaround in the deficit in November 2009. In January and February there was a cumulative surplus of about 0.2 percent of GDP, lower than the surpluses in the first two months of the years 2005 to 2008. In the first two months of 2009, however, there was a deficit. The surplus since the beginning of 2010 is higher than the surplus given by the seasonal path consistent with the budget deficit ceiling, and is due to the upward trend in tax revenues. Budget expenditure accelerated in February, and the monthly expenditure was consistent with the seasonal path representing full performance of the budget.
The foreign exchange market: In the period between the previous monetary policy discussions of February 21 and March 25, the shekel appreciated by 0.3 percent against the dollar, and by 1.3 percent against the euro. In this period the nominal effective exchange rate of the shekel appreciated by 0.5 percent. During the month the euro weakened markedly against most currencies.
The capital and money markets: Between the monetary policy discussions of February 21 and March 25, the Tel Aviv 25 index rose by 4.2 percent, and the Tel Aviv 100 index by 3.7 percent. This was similar to the trend in the major stock exchanges. The Tel Aviv 25 index has returned to its previous peak level. Israel government bonds showed mixed trends, with an increase in yields in unindexed shekel, mainly medium term, bonds, which led to a flattening of the yield curve, in contrast to a drop of about 10–20 b.p in the return on indexed, also mainly medium term, bonds. The yield gap between Israeli and US unindexed 10-year government bonds contracted significantly, to less than 100 b.p., for the first time since the end of 2007. The yield to maturity on twelve-month makam increased, and passed the 2 percent mark, returning to the levels prevailing in January. The positive trend in the Tel-Bond indices persisted, with the Tel-Bond 20 index rising by 1.2 percent, and the Tel-Bond 40 index by 0.4 percent. Israel's sovereign risk premium, as measured by the five-year CDS spread, remained steady at 1.16 percent. CDS spreads of other economies also remained stable, with a slight downward tendency.
The money supply: The M1 monetary aggregate (cash held by the public and demand deposits) decreased by 1.2 percent in February, following its decline of 1.9 percent in January. The M2 aggregate (M1 plus unindexed deposits up to one year) declined by 1.3 percent in February, after increasing by 0.5 percent in January.
The credit market: Total outstanding bank credit dropped in January, with a 0.6 percent decline in credit to the business sector and a modest increase of 0.2 percent in credit to households. Total credit to the business sector fell by about 1 percent in January, to NIS 729 billion. Housing credit continued upwards in January, but at a moderate pace of 0.7 percent, to NIS 157 billion. Against the background of the rising interest rate path, total borrowing via new mortgages declined in February, following an even steeper drop in January. The increase in corporate bond issues continued, but with a greater proportion of lower-rated issuing companies. At the same time the balances of funds specializing in corporate bonds increased, at the expense of money market funds and those specializing in government bonds.
The world economy: Most macroeconomic data published this month indicate that the recovery in the global economy continued, with further growth in the services sector and in employment. Questions remain regarding the sustainability of global growth without governmental support. Inflation and inflation expectations remain low in the advanced economies, mainly in light of the persistent weakness of labor markets and the large output gaps. In the emerging market countries, however, inflationary signs are becoming visible, and some of the large ones are expected to increase their interest rates soon. Central banks and governments face the conflict between the need to continue with monetary and fiscal incentives on the one hand and ballooning deficits and debt/GDP ratios on the other. At the same time, share markets around the world are rising, supported by companies' sound situation, favorable macroeconomic data, and the relative calm with regard to Greece's debt crisis. Nonetheless, the main boost to the markets is still provided by the low levels of interest, which are expected to remain low for the next few months.
The main considerations behind the decision
The decision to increase the interest rate for April to 1.5 percent is part of the gradual process of returning interest to a more "normal" level, intended to return inflation to within the target range and to keep it there, 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, in Israel and globally, 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 current increase is made against the background of growth that continues to become more firmly based, inflation expectations that are close to the upper limit of the target inflation range, and the rise in asset prices. However, monetary policy continues to be expansionary even after this increase.
  Forecasters' average expectations regarding the indices over the next twelve months are for inflation of 2.6 percent. Twelve-month expectations derived from the capital market are close to the upper limit of the target inflation range. Forecasters predict that inflation measured over the previous twelve months will come within the target range a month from now.
  Most indicators, including preliminary findings from the Bank of Israel Companies Survey, suggest that economic activity continued to expand in the first quarter of 2010. There is still uncertainty, however, regarding the strength of the expansion.
  Interest rates of the central banks of the leading advanced economies are very low, and are expected to remain so during the coming months. Nonetheless, some of them are continuing to reduce their use of special instruments of monetary accommodation, and other central banks are starting to increase their interest rates.
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 12 April 2010.
The decision regarding the interest rate for April 2010 will be published at 17:30 on 26 April 2010.