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

22.11.2010
 
The Bank of Israel keeps the interest rate for December 2010 unchanged at 2 percent
The Bank of Israel announces that the rate of interest for December will remain unchanged at its current level of 2 percent.
In addition, the Bank is widening the interest rate corridor around its interest rate in the credit window and the commercial banks' deposit window from ±0.25 percent to ±0.5 percent.
 
Background conditions
Inflation data: The October CPI rose by 0.3 percent, which was the average of forecasters' inflation predictions. The housing component declined by 1.1 percent. Inflation over the previous twelve months was 2.5 percent, within the price stability target range. Since the beginning of 2010 the CPI has increased by 2.2 percent; excluding the housing component, it has increased by 1.5 percent.
Inflation and interest rate forecasts:The average of forecasters' inflation expectations for the next twelve monthly CPIs remained stable at 2.9 percent. Expectations calculated from the capital market, however, increased to slightly above the upper limit of the inflation target. The average of the forecasters' predictions is that the interest rate in a year's time will be 3 percent. Most forecasters expect no change in the Bank of Israel interest rate for December.
Real economic activity: Economic data published this month support the assessment that economic activity continued to increase in the third quarter and in October, at a somewhat slower rate than in the previous quarters. The main reason for the slower pace was the reduction in Israel's foreign trade against the background of the slowdown in world trade. GDP grew in the third quarter at an annual rate of 3.8 percent, compared with a rate of 4.5 percent in the second quarter. Part of GDP growth was due to a 10.2 percent increase in public consumption, and an increase of 9.7 percent in fixed investment. Against the background of the sluggishness in world trade, Israel's exports held steady in October in dollar terms, but in the months August–October average monthly exports were about 7 percent lower than in the previous three months. Imports, however, increased by 9 percent in October, in dollar terms, compared with their September level. The index of Google searches calculated by the Bank of Israel Research Department shows that the probability of recession has fallen to below 50 percent . Two indices of consumer confidence (those of Globes and Bank Hapoalim) fell slightly in October, but remained relatively high. The Purchasing Managers Index increased sharply in October due to increases in the components of demand for exports and production output. The composite state-of-the-economy index for October , which increased by 0.1 percent , shows that expansion continued, but at a slower rate than that evident in the first half of the year.
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 show that the economy is approaching the pre-crisis level of unemployment . The nominal wage accelerated in August, increasing by 1.3 percent, while the real wage increased by 1.1 percent (seasonally adjusted), compared with their levels in July; the increase in the number of employee posts slowed somewhat. Data on Health Tax receipts in October point to a continued increase in the total wage payments. According to Central Bureau of Statistics data, the number of vacancies in the business sector continued to increase, and in October it was 50 percent higher than in October 2009.
Budget data: The domestic deficit (excluding credit) from the beginning of 2010 until October was NIS 12.9 billion, compared with NIS 21.8 billion in January–October 2009. On the basis of the current data, the deficit in 2010, excluding credit, is expected to be about 4 percent of GDP, or even lower, compared with the deficit ceiling of 5.5 percent .
The foreign exchange market: From the previous monetary policy discussion held on October 24 until November 19, the shekel depreciated by 0.14 percent against the dollar, and appreciated by 1.43 percent against the euro, in line with the trends in the international markets. In terms of the nominal effective exchange rate, the shekel appreciated by 0.47 percent in this period.
The capital and money markets: Between the monetary policy discussions of October 24 and November 19, the Tel Aviv share price indices declined, in line with the trends in most stock markets abroad, but also reflecting domestic factors (the energy sector fell by about 10 percent during the period). The Tel Aviv 25 index dropped by about 0.5 percent in this period. Yields on Israeli indexed and unindexed government bonds increased in this period by between 10 basis points (b.p.) and 20 b.p. along the entire curve, except for short-term indexed bonds the yields on which fell slightly. These developments regarding Israeli government bonds showed the same general trends as did government bonds abroad, but to a more moderate extent. Yields on makam fell along the entire curve. The yield gap between Israeli and US unindexed 10-year government bonds contracted slightly this month, to 170 b.p., as yields on the US bonds increased more sharply than those on Israeli government bonds. In the corporate bond market the Tel-Bond 20 and the Tel-Bond 40 indices fell by 0.25 percent and 0.4 percent respectively. The yield gap between them and government bonds showed a mixed picture, with that between the highest- and lowest-rated bonds and government bonds contracting, while that between the other bonds and government bonds widened slightly. Israel's sovereign risk premium as measured by the five-year CDS spread fell slightly this month, in contrast with the trend around the world, and reached 111 basis points.
The money supply: The M1 monetary aggregate (cash held by the public and demand deposits) decreased by 1.2 percent in October, following its 2.4 percent increase in September. In the last twelve months the M1 aggregate increased by 4.6 percent. The M2 aggregate (M1 plus unindexed deposits of up to one year) fell by 0.2 percent in September, following its 1.7 percent increase in September; in the last twelve months it increased by 0.9 percent.
The credit market: Total outstanding business sector credit remained steady in September, at NIS 756 billion, after increasing by 1.2 percent in August, and by less than 3 percent since the beginning of 2010. Credit to households increased by a modest 0.3 percent in September, as a result of a moderate increase in the volume of mortgages, reflecting seasonal factors; since the beginning of the year this credit has increased relatively rapidly, by 7 percent. New mortgages granted in October increased again, by 11 percent, following their decline in September, so that the value of new mortgage issues returned to the level prior to the summer months.
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––continued to increase. In August–September they increased by 1.9 percent, following an increase of 1.3 percent in July–August. Since the beginning of the year house prices have risen by 11.6 percent, and in the last twelve months by 19.7 percent. In contrast, the housing index, which is based on renewed rental contracts and which is included in the CPI, fell by 1.1 percent in October.
The global economy: Most economic data published this month present a positive picture, particularly with regard to the US economy, and less so with regard to Europe. In Europe concern grew over a debt crisis in several countries. It is generally assessed that the global economy has recovered from the trough level it reached, and that the probability of another recession has declined. Some investment houses updated their growth forecasts for the coming quarters upwards, but the OECD reduced its forecasts. The rate of growth of the global economy continues to constitute the main cause for concern. Inflation in the advanced economies remains low, mainly due to their output gaps. In the emerging market economies inflationary pressures grew stronger, due mainly to the increases in commodity prices. In several countries intervention in foreign currency markets continued this month, including in some the imposition of restrictions on capital flows. In the leading economies monetary policy continued to be expansionary, and in the US another quantitative easing program, QE2, was activated. Several central banks of economies that are already showing relatively rapid growth continued last month with their process of increasing interest rates.
The main considerations behind the decision
The decision to keep the interest rate for December 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 is within the target range, and according to predictions of the private forecasters and of the Bank of Israel Research Department it is expected to be slightly above the upper limit of the inflation target range in the first half of 2011, and then to return to within the target range. Inflation expectations calculated from the capital market for one year ahead were slightly above the upper limit of the target range this month.
  Most of last month's economic indicators support the assessment that economic activity continued to expand in the third quarter and in October. The decline in exports, however––reflecting the effect of the weakness of world trade––following the rapid increase in exports in the first half of the year, also featured prominently in the data. The lack of certainty regarding the sustainability of domestic growth deriving from uncertainty about global demand still constitutes a significant risk factor.
  Interest rates of the leading advanced economies' central banks are low, and are expected to remain low for a long time; the Fed reintroduced instruments of quantitative easing. Against this background, the differentials between interest rates in countries with relatively rapid rates of growth, including Israel, and those in the advanced economies present a serious challenge for policy makers in the rapidly growing economies who need to strike a balance between domestic pressures to increase the interest rate and the effect such an increase may have with regard to appreciation of their currency and its effect on exports and economic activity.
  House prices (which are not included in the CPI) continued to increase rapidly. The Bank of Israel will continue to monitor the effects of the policy measures it introduced in the real estate market, which are intended to support financial stability and to moderate the rate of house price increases in the coming months.
In light of the above considerations, the Governor decided to keep the rate of interest unchanged for December, at 2 percent.
As part of the process of normalizing monetary policy, the Bank of Israel has decided to widen the interest rate corridor around its interest rate in the credit window and the commercial banks' deposit window from ±0.25 percent to ±0.5 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 especially on house prices.
The minutes of the discussions prior to the above interest rate decision will be published on December 6, 2010.
The decision regarding the interest rate for January 2011 will be published at 17:30 on Monday, December 27, 2010.