The Bank of Israel keeps the interest rate for November 2010 unchanged at 2 percent

25.10.2010
 
The Bank of Israel keeps the interest rate for November 2010 unchanged at 2 percent
The Supervisor of Banks has published new directives regarding floating-interest leveraged housing
 
Background conditions
Inflation data: The September CPI rose by 0.3 percent, slightly more than the average of forecasters' predictions of an increase of 0.2 percent. The rise was due mainly to increases in prices of fruit and vegetables and housing. Inflation in the last twelve months was 2.4 percent, within the price-stability target range. Since the beginning of 2010 the CPI has risen by 1.9 percent. Excluding the housing index, which has risen by 5.6 percent since the beginning of the year, the CPI rose by only 0.8 percent in January–September 2010. The rise in the overall CPI from the beginning of the year to September is consistent with inflation of 2.4 percent in the year 2010.
Inflation and interest rate forecasts: Twelve-month inflation expectations derived from the capital market remained steady, close to the upper limit of the target inflation range; private forecasters' expectations for the increases in the next twelve CPIs declined slightly this month to 2.9 percent. On average, the forecasters expect inflation in 2010 to be 2.4 percent. The Bank of Israel interest rate a year hence is expected to be 2.7 percent. Most forecasters expect no change in the Bank of Israel interest rate for November.
Real economic activity: Economic data published this month show that the pace of growth slowed somewhat. Foreign trade data (seasonally adjusted) show a 4.6 percent drop in exports in the third quarter compared with the second quarter, and a small 0.5 percent increase in imports; the Purchasing Managers Index stayed at the low level it had reached in the second quarter; the Google Search Index calculated by the Bank of Israel Research Department points to some increase in the probability of a recession. In contrast to these indications, according to the Bank of Israel Companies Survey for the third quarter, companies reported a continued increase in activity in the third quarter, with the increase encompassing all industries apart from construction. Furthermore, both the domestic market and exports grew. All the components of tax revenues increased in September, another factor consistent with expanded activity. The Globes and the Bank Hapoalim consumer confidence indices both rose again in September, following their rise in August.
The Bank of Israel staff forecast is that inflation in the next twelve months will be 2.5 percent, with a gradual increase in the interest rate to about 2.9 percent by the end of 2011. Risks to real activity and inflation in Israel derive essentially from developments abroad.
The labor market and wages: Labor market data this month also present a mixed picture. The Ministry of Industry, Trade and Labor Employers Survey for the third quarter reported a small increase in the demand for employees. The balance of employment (the difference between the number of vacancies filled and the number of terminations of employment) remained positive, but lower than that in the second quarter. The number of claims for unemployment benefits increased in August. Central Bureau of Statistics data for September show a 1.4 percent increase in the number of vacancies over the number in August. Health Tax receipts in September also indicate a continued increase in total wage payments. The rising trend in the nominal and real wage evident in the last few months reversed in July, with a decline of 0.8 percent in the nominal wage, and of 0.6 percent in the real wage (both seasonally adjusted).
Budget data: From the beginning of 2010 until September the domestic deficit was NIS 10.9 billion, compared with NIS 19.6 billion in January–September 2009. On the basis of the current data, the deficit in 2010, excluding credit, is expected to be 4 percent of GDP, or even lower.
The foreign exchange market: From the previous monetary policy discussion held on September 26 until October 22, the shekel appreciated by 1.5 percent against the dollar, and depreciated by 2.4 percent against the euro, in line with the trends in the international markets. In terms of the nominal effective exchange rate, the shekel depreciated by 0.5 percent in this period.
The capital and money markets: Between the monetary policy discussions of September 26 and October 22, the Tel Aviv share price indices showed trends similar to those in most stock markets abroad: the Tel Aviv 25 index rose by 3.7 percent, surpassing its previous peak level (recorded in April this year). Yields on Israeli government bonds declined in general in this period, and yields on makam fell along almost the entire curve. Yields on local-currency government bonds showed mixed trends: the curve flattened, with yields up to three years increasing, and yields on medium- and long-term bonds falling. Yields on CPI-indexed government bonds declined steeply along the whole curve. The yield gap between Israeli and US unindexed 10-year government bonds contracted slightly this month. In the corporate bond market the Tel-Bond 20 and the Tel-Bond 40 indices rose by 3.3 percent, and the yield gap between them and government bonds narrowed. Israel's sovereign risk premium as measured by the five-year CDS spread fell slightly this month, in line with the trend around the world, and reached 116 basis points.
The money supply: The M1 monetary aggregate (cash held by the public and demand deposits) increased by 2.4 percent in September, following its 0.6 percent decrease in August. In the last twelve months the M1 aggregate increased by 4.2 percent. The M2 aggregate (M1 plus unindexed deposits of up to one year) increased by 1.7 percent in September, following its 1.2 percent decline in August; in the last twelve months it increased by 1 percent.
The credit market: Total outstanding business sector credit increased by 1.2 percent in August, to NIS 755 billion, after remaining unchanged in July. In this total, bank credit also increased by 1.2 percent from its July level. Outstanding nonbank credit (corporate bonds and nonbank loans) remained steady in August. Credit to households increased by 0.9 percent in August. New mortgages dropped sharply in September from their August level. It should be noted that the Jewish High Holydays occurred in September this year, and the decline in new mortgages in September followed three months of high mortgage figures, largely due to seasonal factors.
The housing market: House prices––which are presented in the Central Bureau of Statistics survey of house prices and which are not included in the CPI––increased again, at an even faster rate of 1.3 percent in July–August compared with an increase of 0.7 percent in June–July. Since the beginning of the year house prices have risen by 9.7 percent, and in the last twelve months by 19.0 percent. Some of the rise in the rental cost of housing, which is included in the CPI, is apparently due to the persistent and steep increase in house prices.
The global economy: In October the IMF increased its forecast of global growth in 2010 from 4.6 percent to 4.8 percent in light of second quarter growth figures that exceeded expectations. The IMF nonetheless expects that there will be a certain slowdown in growth in the advanced economies starting in the second half of 2010 and continuing in the first half of 2011. The IMF forecasts 4.2 percent global growth in 2011, a slowdown compared with growth in 2010.. Sizable capital inflows into the emerging markets boosted activity in the international foreign currency markets, with increased intervention in the markets both in the form of purchases of foreign currency by central banks and via the imposition of restrictions imposed on capital movements. Inflation remained at a low level in the advanced economies, mainly due to their output gaps. In the emerging markets, inflationary pressures strengthened, following the increase in commodity prices. Against the background of the persistent weakness of the leading advanced economies, the increased risk of further deterioration, and concern over deflation, investors' expectations of continued and even more extensive quantitative easing in those economies increased.
The main considerations behind the decision
The decision to keep the interest rate for November unchanged at 2 percent is consistent with the gradual process of returning the interest rate to a more 'normal' level intended to position inflation firmly within the target range, and to support the further recovery of economic activity, while maintaining financial stability. The path of the interest rate is not pre-determined, but is set in accordance with the inflation environment, growth in Israel and globally, the monetary policies of the leading central banks, and developments in the exchange rates of the shekel. At the current level of the interest rate, monetary policy continues to be expansionary.
    Inflation in the last twelve months has been within the target range for about five months, and is expected to remain within it in the next few months. However, inflation expectations calculated from the capital market for one year ahead and those of the private forecasters remain close to the upper limit of the target inflation range, partly due to expectations that housing prices will continue to increase. The housing component of the CPI, which relates to rentals, continues to feature prominently as a factor contributing to the rise in the CPI. House prices, taken from the Central Bureau of Statistics survey of house prices, continued to increase rapidly.
  From the financial stability aspect, the persistent increase in house prices and the growth in credit for house purchases, due in part to the low interest rate, necessitate the introduction of measures to counter these trends. Therefore, following steps taken previously by the Bank of Israel, the Supervisor of Banks has issued a draft directive to the banks instructing them to increase their capital provision for housing loans at floating interest with high loan-to-value (LTV) ratios. These measures are expected to restrain the increase in house prices, and hence also gradually to moderate the increase in the housing component of the CPI.
  This month's economic data indicate some slowing of the rate of growth of output, mainly reflecting a fall in exports, with increased uncertainty regarding the sustainability of growth deriving from uncertainty about global demand.
  Interest rates of the leading advanced economies' central banks are low, and in light of the latest developments are expected to remain low for a long time, and some central banks are preparing to renew measures of quantitative easing.
In light of the Bank of Israel's decision to introduce a further macroprudential measure with regard to housing finance, and its implications for inflation, and in light of the indications of a slowdown in growth, the Governor decided to keep the rate of interest unchanged for November, at 2 percent.
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, including keeping a close watch on developments in the housing market, and specially on house prices.
The minutes of the discussions prior to the above interest rate decision will be published on November 8, 2010.
The decision regarding the interest rate for December 2010 will be published at 17:30 on Monday, November 22, 2010.