The Bank of Israel keeps the interest rate for January 2011 unchanged at 2 percent

27.12.2010
 
The Bank of Israel keeps the interest rate for January 2011 unchanged at 2 percent
The Bank of Israel announces that the rate of interest for January 2011 will remain unchanged at its current level of 2 percent.
 
Background conditions
Inflation data: The November CPI rose by 0.1 percent, within the range of forecasters' inflation predictions of an increase of between 0 percent and 0.3 percent. Inflation in the last twelve months and since the beginning of 2010 stands at 2.3 percent, within the range of the price stability target. Excluding the housing component, the CPI has increased by 1.6 percent since the beginning of 2010.
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, decreased slightly, and are slightly below the upper limit of the inflation target range. The average of the forecasters' predictions is that the interest rate in a year's time will be 3.1 percent. Most forecasters expect no change in the Bank of Israel interest rate for January 2011.
Real economic activity: Economic data published this month support the assessment that economic activity continued to increase at a rate similar to that in the third quarter, in line with the Bank of Israel forecast of 4 percent GDP growth in 2010. Initial partial data from the Bank of Israel Companies Survey for the fourth quarter indicate that economic activity continued to expand in all industries. The composite state-of-the-economy index for November, which increased by 0.1 percent following similarly moderate increases since July, indicates that economic activity continued to grow slowly. Government indirect and direct tax revenues continued to follow an upward trend in November. The Purchasing Managers Index increased in November, and was above 50 percent for the fourth consecutive month, indicating expansion. Consumer confidence indices declined this month, but their level still indicates continued growth. Foreign trade data show that goods exports increased moderately in November, and services exports surged by 11 percent in October, following a sharp increase also in September.
The Bank of Israel staff forecast is that inflation in 2011 will be 2.6 percent, with a gradual increase in the interest rate to about 3.3 percent in the third quarter of the year. The main risks to real activity and inflation in Israel derive from developments abroad and in the local housing market.
The labor market and wages: The positive developments in the labor market in the first half of the year continued in the third quarter. The unemployment rate increased to 6.6 percent in the third quarter from 6.4 percent in the second, but according to the Central Bureau of Statistics Manpower Survey Labor, this increase was accompanied by a 0.6 percentage point increase in the employment rate to 54 percent, and a 0.7 percentage point increase in the participation rate to 57.8 percent. The average real wage per employee post increased by 0.4 percent in the third quarter compared with the second, and the nominal wage by 0.7 percent (both seasonally adjusted). Data on Health Tax receipts in November point to an increase in total wage payments compared with the total in November 2009.
Budget data: The domestic deficit (excluding credit) from the beginning of 2010 until November was NIS 12.8 billion, compared with NIS 24.1 billion in January–November 2009. On the basis of the current data, the deficit in 2010, excluding credit, is expected to be about 3.5 percent of GDP, compared with the deficit ceiling of 5.5 percent of GDP. Assessments of the costs of the Carmel fire are that from a macroeconomic standpoint they will not be significant.
The foreign exchange market: From the previous monetary policy discussion held on November 21 until December 24, the shekel appreciated by 1.3 percent against the dollar, and by 5.5 percent against the euro, in line with the trends in countries showing rapid growth. In terms of the nominal effective exchange rate, the shekel appreciated by 2.8 percent in this period.
The capital and money markets: Between the monetary policy discussions of November 21 and December 24, the Tel Aviv share price indices increased, in line with but more moderately than the trends in most stock markets abroad. The Tel Aviv 25 index increased by about 3.2 percent in this period. Yields on Israeli indexed and unindexed government bonds increased in this period by between 10 and 30 basis points (b.p.) along the entire curve, with indexed bonds showing the greater increase. These developments regarding Israeli government bonds showed the same general trends as did government bonds abroad, which started with steep increases in yields in the US, although the increase in Israel was a more moderate one. Yields on makam increased along the entire curve as it flattened. The yield gap between Israeli and US unindexed 10-year government bonds contracted greatly this month, to 128 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 index fell by 1.3 percent, and the Tel-Bond 40 index by 1.4 percent. The yield gap between corporate bonds of all ratings and government bonds increased, in contrast to the worldwide trend and in contrast to the trend last year. Israel's sovereign risk premium as measured by the five-year CDS spread increased slightly this month, to 116 b.p., in line with the trend in markets unaffected by the European debt crisis.
The money supply: The M1 monetary aggregate (cash held by the public and demand deposits) decreased by 1 percent in November, following its 0.7 percent reduction in October. In the last twelve months the M1 aggregate increased by 1.7 percent. The M2 aggregate (M1 plus unindexed deposits of up to one year) increased by 1 percent in November, after remaining unchanged in October; in the last twelve months it increased by 2 percent.
The credit market: Total outstanding business sector credit declined slightly in October, to NIS 747 billion, following a small drop in September; since the beginning of the year it has risen by about 2 percent. Credit to households increased by 1 percent in October, as a result of an increase in the volume of mortgages and in non-housing credit; since the beginning of the year outstanding credit to households has increased by 10.6 percent.
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 in September–October at a rate of 0.4 percent a month, following their increase of 1.9 percent in August–September. Since the beginning of the year house prices have risen by 12.2 percent, and in the last twelve months by 18.2 percent. The housing index, which is based mainly on renewed rental contracts and which is included in the CPI, remained unchanged in November, after falling by 1.1 percent in October.
The global economy: As in the previous month, most economic data published this month present a positive picture with regard to the US, China, and in some countries in Europe, prompting the investment houses to significantly increase their forecasts of growth in the next few years. The revision regarding the US is the most notable, with forecast growth for 2011 being increased from 2.5 percent to 3.1 percent. In the US large amounts of liquidity are being injected as part of the monetary expansion, e.g. via the quantitative easing (QE2) policy, and a new fiscal program, consisting mainly of tax relief. The markets brought forward their forecast timing of an increase in the interest rate in the US. In Europe the debt crisis spread, with reductions in the ratings and rating outlooks in the European PIGS and doubts about other countries. In contrast, Europe as a whole, spearheaded by Germany, generally presented surprisingly buoyant macroeconomic data; in the third quarter these were based on domestic demand, and not only exports. In the emerging market economies, headed by China, rapid growth persisted. The favorable economic data published on the one hand, and the concern resulting from the high levels of debt and the European debt crisis on the other, prompted investors to switch this month from government bonds to risk assets and led to capital inflows into countries with high growth rates. The outcome was steep increases in yields on government bonds, strengthening of the currencies of countries with rapid growth, and increases in share prices. Inflation remained low in the advanced economies. Increased demand for commodities pushed their prices to record levels, boosting inflation in the emerging markets.
The main considerations behind the decision
The decision to keep the interest rate for January 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 rate of increase in 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.
  Interest rates of the leading advanced economies' central banks are low, and are expected to remain low for a long time. Against this background, the differentials between interest rates in countries with relatively rapid rates of growth, including Israel, and those in the advanced economies––differentials which encourage short-term capital flows that tend to create pressure for the appreciation of the domestic currency––present a serious challenge for policy makers.
  Inflation expectations for one year ahead calculated from the capital market and those of forecasters declined a little and entered the target inflation range, and are currently slightly below its upper limit. The Bank of Israel Research Department forecast is that inflation in the coming year will be 2.6 percent, partly due to the appreciation of the shekel last month. Inflation over the previous twelve months is expected to be slightly above the upper limit of the inflation target range during most of 2011, and then to return to within the target range towards the end of the year.
  House prices increased at a slower rate last month, while the housing component of the CPI declined in the last two months, partly due to the measures introduced by the Bank of Israel and the government to cool the real estate market. However, it is still early to know whether there has been a change in the trend of house prices. The Bank of Israel will continue to monitor the developments in this market, and will take whatever steps are needed to underpin financial stability.
  Most of this month's economic indicators support the assessment that economic activity in Israel continues to expand at a rate of about 4 percent per annum. The investment houses revised their growth forecasts for the US upwards. Nevertheless, the debt crisis in several European countries is likely to reduce the pace of recovery in those countries and accordingly presents a risk to the rate of growth in Israel.
In light of the above considerations, the Governor decided to keep the rate of interest unchanged for December, 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 assets market, and especially in the housing market.
The minutes of the discussions prior to the above interest rate decision will be published on January 9, 2011.
The decision regarding the interest rate for February 2011 will be published at 17:30 on Monday, January 24, 2011.