The Bank of Israel keeps the interest rate for May 2010 unchanged at 1.5 percent

26.04.2010
 
The Bank of Israel keeps the interest rate for May 2010 unchanged at 1.5 percent
 
The Bank of Israel announces that the interest rate for May 2010 will remain unchanged at 1.5 percent.
Background conditions
Inflation data: The CPI for March rose by 0.1 percent, in line with the forecasts. The housing component rose by 0.6 percent, following three months of decline that totaled about 2 percent.. In the last twelve months the CPI rose by 3.2 percent, and excluding the effect of the changes in indirect taxes and the water surcharge, by 2.7 percent.
Inflation and interest rate forecasts: Forecasters expect that inflation as reflected in the CPI in the next twelve months (April 2010 to March 2011) will average 2.7 percent; and on average they expect inflation in 2010 to be 1.8 percent. They forecast that with the publication of the April index, inflation measured over the previous twelve months will return to within the target range. Inflation expectations for the next twelve months calculated from the capital market declined from close to the upper limit of the target inflation range to 2.7 percent. With regard to the Bank of Israel interest rate, the forecasters expect, on average, an increase of 0.3 percentage points over the next three months, and a rate of 3.0 percent in a year's time. Expectations calculated from the capital market are for an interest rate of 2.6 percent in a year's time.
Real economic activity: Many indicators show that the expansion of real economic activity is continuing, but some show that the rate of increase has slowed. On the positive side, the Bank of Israel's Companies Survey for the first quarter of 2010 shows that business activity continued to expand, and the leading index in the Survey reflects expectations of further expansion in the second quarter, and foreign trade data for March point to renewed acceleration in goods imports and exports. The Bank of Israel composite state-of-the-economy index for April rose by 0.6 percent. In contrast to these indications, the rate of increase of direct and indirect tax revenues moderated somewhat, the expectations component of consumers' confidence indices declined, and the probability of a slowdown in demand in April increased (based on the Google search index calculated in the Bank's Research Department). The Bank of Israel's forecast of growth in 2010 was revised upwards last week from 3.5 percent to 3.7 percent, and the forecast for 2011 is of 4 percent growth.
The labor market and wages: The various labor market indicators taken together suggest a gradual improvement. Seasonally adjusted National Insurance Institute figures show that the number of employee posts in January 2010 was 0.5 percent higher than in December, and 1.9 percent higher than in January 2009. The real wage fell by 1.7 percent in the period November 2009 to January 2010 compared with the same period a year previously, the nominal wage increased by 2 percent, and the number of employee posts increased by 0.2 percent. The upward trend in health tax receipts that started in July 2009 continued in March.
Budget data: In the first quarter of 2010 the domestic deficit was NIS 1.9 billion, compared with NIS 3.8 billion in the first quarter of 2009. In the first quarter of the years 2005–08, however, there was a budget surplus. The deficit in the first quarter of 2010 is NIS 2 billion lower than that given by the seasonal path consistent with the budget deficit ceiling. This deviation from the path is due mainly to the fact that tax revenues were NIS 2.5 billion higher than in the budget forecast.
The foreign exchange market: In the period between the previous monetary policy discussions of March 25 and April 25, the shekel appreciated by 0.2 percent against the dollar, and by 0.9 percent against the euro. Nevertheless, in terms of the nominal effective exchange rate, the shekel depreciated marginally, by 0.1 percent, as a result of the strengthening of the other currencies included in the currency basket against which the rate is calculated. During the month the euro continued to weaken against most major currencies, in light of Greece's debt crisis.
The capital and money markets: Between the monetary policy discussions of March 25 and April 25, the Tel Aviv 25 index and the Tel Aviv 100 index both dropped by 1.9 percent. This was in contrast to the positive trend in the major stock markets. In the course of the period, the Tel Aviv 25 index surpassed its previous peak level, but as stated, at the end of the period it declined. The yields on Israeli government bonds were relatively stable this month, with a slight flattening of the nominal and indexed yield curves.
The yield gap between Israeli and US unindexed 10-year government bonds widened again this month, by 15 b.p., to 115 b.p. There was continued lively interest in makam, also among foreign investors, who continued to expand their activity in the primary market and also in the secondary market, which recorded high levels of trade. Yields to all terms increased by about 15–25 b.p. this month along the entire curve Over the period the Tel-Bond 20 index and the Tel-Bond 40 index edged down by about 0.1 percent. Israel's sovereign risk premium, as measured by the five-year CDS spread, declined, in line with the reductions in the premiums of the emerging market economies, and reached 109 b.p, a drop of about 7 basis points from the previous month.
The money supply: The M1 monetary aggregate (cash held by the public and demand deposits) increased by 2.4 percent in March, following its decline of 1.8 percent in February. The M2 aggregate (M1 plus unindexed deposits up to one year) declined by 0.8 percent in March, further to its fall of 1.4 percent in February.
The credit market: Outstanding business sector bank credit increased in February by 0.9 percent, to NIS 389 billion. Total business sector debt grew by 0.7 percent in February, to NIS 737 billion. New mortgages granted increased again in March, to NIS 3.6 billion.
The world economy: The recovery trend in the global economy continued this month. Most incoming data indicate that the recovery in the global economy is becoming more firmly entrenched, due in part to the continued strong growth in East Asian countries and positive signs of recovery in the US. Against this background the IMF revised its growth forecast upwards. Reports also showed that the probability of the start of another recession has receded. Nevertheless, in the advanced countries, growth is heavily influenced by extremely expansionary monetary and fiscal policies. The exit from these policies could pose a threat to the strength of the recovery. Additional risks persist, particularly the global debt crisis, which became even more severe towards the end of the period, against the background of Greece's debt crisis. The monetary policy of the main central banks continues to be expansionary. Concurrently, in other countries the trend towards a tighter monetary policy persists. Nonetheless, global inflation is still low, and there is no concern over an inflationary spurt in the coming year.
The main considerations behind the decision
The decision to keep the interest rate for May unchanged at 1.5 percent is part of the gradual process of returning interest to a more "normal" level, intended to position inflation firmly 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 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. At the current level of the interest rate, monetary policy continues to be expansionary.
  The inflation rate over the past twelve months declined to 3.2 percent, and since the beginning of 2010 the price level has declined by 0.9 percent. Seasonally adjusted and excluding the reduction in indirect taxes and the abolition of the water surcharge, inflation since the beginning of the year was 0.6 percent. It is expected that after the publication of the April CPI, inflation over the previous twelve months will enter the target range and later in the year is even expected to fall below the midpoint of the range. Inflation expectations calculated from the capital market declined to 2.7 percent, after several months when they rose slowly and were close to the upper limit of the target range. Forecasters' predictions of inflation one year ahead remained stable at an average of 2.7 percent.
  Data that became available this month, in particular the Bank of Israel Companies Survey and foreign trade data, support the assessment that economic growth in Israel is becoming more firmly entrenched. At the same time, according to the updated Bank of Israel forecast, the process of closing the output gap is expected to be a gradual one.
  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 unconventional instruments of monetary accommodation, and other central banks are starting to increase their interest rates.
These three factors support a gradual increase in the interest rate, and therefore, following the increase in the rate last month, the Governor decided to leave the interest rate unchanged for May.
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 May 10, 2010.
The decision regarding the interest rate for June 2010 will be published at 17:30 on Monday, May 24, 2010