The Bank of Israel leaves the interest rate for August 2011 unchanged at 3.25 percent

25.07.2011
 
The Bank of Israel leaves the interest rate for August 2011 unchanged at 3.25 percent
 
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Background conditions
Inflation data:The inflation rate over the last 12 months was 4.1 percent, above the upper limit of the target inflation range (of 1–3 percent a year). The Consumer Price Index (CPI) rose by 0.4 percent in June, in line with the forecasts and at the upper limit of the seasonal path consistent with achieving the inflation target. The June index was affected, as was the May index, by the continued increase in the housing and food components of the index. The inflation rate, as measured by the seasonally adjusted index, was slower in the last four months than in the preceding months.
Inflation and interest rate forecasts:Inflation expectations of forecasters for the next twelve months remained unchanged this month at 2.9 percent, slightly below the upper limit of the target range. Inflation expectations as calculated from the capital market also remained stable this month at an average of 3 percent. Based on the Telbor (Tel Aviv Inter-Bank Offered Rate) market, the Bank of Israel interest rate one year from now is expected to be 4 percent, and the average of forecasters' predictions is that it will be 4.3 percent. Most forecasters expect the Bank of Israel to leave the interest rate for August unchanged.
Real economic activity:Economic indicators that became available this month show that economic activity continued to expand, albeit more slowly than in the first quarter. The slowdown in the rate of growth stems mainly from moderation in the activity of the exporting industries. Goods exports (excluding diamonds, ships and aircraft, seasonally adjusted) declined by 2.4 percent, quarterly rate, in the second quarter compared with the first. Imports (excluding diamonds, ships and aircraft, seasonally adjusted) grew at a quarterly rate of 10.3 percent in the second quarter. The Bank of Israel Companies Survey for the second quarter and the Central Bureau of Statistics survey of business trends for June both report expectations of continued expansion of activity. Consumer confidence indices remained unchanged at a relatively high level, but is seems that economic developments around the world and geopolitical developments in Israel are having a negative effect on the expectations component of these indices. The composite state-of-the-economy index for June increased by 0.2 percent, continuing the relatively modest increases in the last few months. In the second quarter the index rose by 0.7 percent, compared with an increase of 1.4 percent in the first quarter.
The Bank of Israel staff forecast is that inflation in the next twelve months will be 2.9 percent, with the interest rate increasing to an average of 3.4 percent in the third quarter of 2011 and to about 4 percent in a year's time. This is against the background of a 0.2 percentage point reduction in the forecast rise in the interest rate in the G4 countries, both one quarter hence and one year hence, and a reduction of 0.3 percentage points in the GDP growth forecast of those countries one quarter ahead, and by 0.1 percentage points one year ahead. The Research Department emphasized the main risks facing Israel's economy: the realization of the pessimistic assessments regarding the global economic recovery and its expected impact on demand for Israel's exports; and negative geopolitical developments.
The labor market and wages: Labor market data indicate a continued improvement in employment. The trend figure for May shows 5.7 percent unemployment in the civilian workforce. The number of employee posts (seasonally adjusted) increased by 0.3 percent in February–April compared with the previous three months. The number of vacancies increased by 8 percent in the second quarter––after remaining stable in the first quarter––although in June the seasonally adjusted figure showed a decrease. The nominal wage increased in February–April by 1.1 percent compared with the level in the previous three months, while the real wage remained unchanged (three-monthly rates, seasonally adjusted). Health tax receipts in June, which provide an indication of wage payments in that month, were 7.6 percent higher, in nominal terms, than in June 2010 (excluding the effect of legislative changes). The minimum monthly wage was increased from NIS 3,900 to NIS 4,100 at the beginning of July.
Budget data: Tax revenues in January–June were 7.1 percent higher, in real terms, than in the corresponding period last year, and NIS 0.3 billion higher than the seasonal path of the budget forecast. The government's domestic activity in the first half of this year (excluding credit) resulted in a cumulative surplus of 0.3 percent of GDP, compared with a deficit of 1.1 percent of GDP in the corresponding period of 2010.
The foreign exchange market: From the previous monetary policy discussion held on June 26, through July 22, the shekel appreciated by 1.6 percent against the dollar, lower than the appreciation of the main currencies against the dollar. Against the euro the shekel strengthened by about 0.3 percent. In terms of the nominal effective exchange rate the shekel strengthened by about 0.6 percent.
The capital and money markets: Between the monetary policy discussions of June 26 and July 22, most Tel Aviv Stock Exchange share price indices rose, in line with the general trend in stock markets abroad, but with lower volatility. The Tel Aviv 100 Index rose by 5.3 percent. Yields on local currency government bonds declined by 4–20 basis points (b.p.), mainly in the medium term. Yields on CPI-indexed government bonds showed a sharper drop of 20–35 b.p., with the curve becoming steeper. The yield gap between Israeli unindexed 10-year government bonds and US 10-year Treasury notes contracted during the period surveyed, and at the end of the period stood at 218 b.p. (down from 235 b.p. at the beginning of the period). Makam yields edged down by 2–5 b.p., with some slight steepening of the curve. New corporate bond issues totaled a gross NIS 5.5 billion in June, bringing the year to date total to about NIS 25 billion, similar to the amount in the corresponding period in 2010. The yield spread between the Tel-Bond 40 and government bonds widened by 14 b.p. to 2 percent. Over the period as a whole, Israel's sovereign risk premium as measured by the five-year CDS spread declined, and at the end of the period was 138 b.p.
The money supply: In the twelve months ending in June the M1 monetary aggregate (cash held by the public and demand deposits) increased by 8.4 percent, and the M2 aggregate (M1 plus unindexed deposits of up to one year) increased by 9.5 percent.
Developments in the market for housing credit: The balance of outstanding credit to the business sector increased in May by 0.4 percent, to NIS 750 billion. Outstanding credit to households increased by 1.5 percent in May, to NIS 351 billion. Of the credit to households, outstanding housing credit rose 14.4 percent in the twelve months ending in May, to NIS 246 billion, compared with a 14.1 percent increase in the twelve months to April. There was a decline in new mortgages granted in June, and as a result, for the first time since July 2009, total mortgages extended in the previous twelve months declined, by 1.4 percent. This contrasts with the usual summer trend of an increase in mortgages in the summer months. The share of new mortgages granted in June that were not indexed to the CPI, at variable interest rates, fell significantly, to 32 percent, down from 45 percent in May. The reduction in this share was due among other things to a directive issued by the Supervisor of Banks regarding the maximum permitted share of a housing loan at a floating interest rate that went into effect on May 5, 2011; the directive is expected to continue to have an effect in the future. Interest rates on new CPI-indexed and unindexed variable-interest mortgages increased in June, while interest rates on new CPI-indexed mortgages fixed interest were unchanged .
The housing market: The supply of houses continues to increase, and in the twelve months to April building starts totaled 41,583, compared with 37,489 starts in the twelve months to April 2010––an 11 percent increase. Completions totaled 33,841 in the twelve months to April, compared with 31,374 in the twelve months to April 2010––a 7.9 percent increase. Since the beginning of the year there has been a marked moderation in the sale of new houses, with a rise in the number of houses for sale. House prices––which are presented in the Central Bureau of Statistics survey of house prices but are not included in the CPI––increased in April–May at a rate of 0.7 percent a month, following their increase of 1.5 percent a month in March–April. The annual rate of increase in house prices declined slightly, but continues to be high, and in the twelve months that ended in May, house prices increased by 13.7 percent; compared with a 14.5 percent increase in the previous month's figure. The housing index, which is based mainly on renewed rental contracts and which is included in the CPI, continued to increase, rising by 0.5 percent in June, bringing the increase in the last twelve months to 6.2 percent. The effect of the increase in the interest rate, measures introduced by the Bank of Israel affecting mortgages, and steps taken by the Ministry of Finance in real estate taxation, together with the continued increase in the number of building starts, are expected to be reflected in house prices in the course of the coming year.
The global economy: The debt crisis in Europe spread to major eurozone countries, especially Italy. The credit rating companies lowered the ratings of Greece, Ireland and Portugal severely, and lowered the rating outlook of Italy and Spain. However, in the last few days, agreement was reached on a European aid program for Greece (which can also help other countries), a program that was better than expected, and thus calmed the markets somewhat. In the US too the debt continues to be headline news as a result of the inability to reach an agreement about increasing the debt ceiling and its attendant cuts. This has led to threats by the rating companies to lower the US credit rating in the near future. Most macroeconomic data published this month indicate weakness, as a result of which many investment houses reduced their annual growth forecasts, with expectations of some recovery in the second half of the year. Inflation remained high world wide, driven by the steep increase in commodity and energy prices in the last few months. This led to increases in interest rates in the rapidly growing emerging market economies, and even in Europe. The Fed, however, which focuses on the core index, assessed that this was a temporary development, and that inflation would decline again and would not be reflected in the core index. At the same time, in light of the complex reality of inflation on one side and concern over growth on the other, the general assessment is that increases in the interest rate will be more moderate than expected in the last few months.
The main considerations behind the decision
The decision to leave the interest rate for August at 3.25 percent is consistent with the process of returning the interest rate to a more normal range intended to position inflation firmly within the target range, and to support further growth, 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, economic 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 over the previous twelve months, 4.2 percent, continues to be high. However, the seasonally adjusted CPI inflation rates in the last four months are in line with the target inflation range. Forecasters’ inflation expectations for the next twelve months remained steady at slightly below the upper limit of the target range. Forecasters' inflation expectations and those derived from the capital market go together with the assessment that the Bank of Israel will continue to increase the interest rate, but at a slower pace than in the first half of the year.
  Most economic indicators published this month support the assessment that the rate of growth in economic activity in Israel moderated in the second quarter primarily as a result of the slower expansion of goods exports. In addition, developments in debt crises, the weakness of the US economy, and geopolitical risks, increase uncertainty about the pace of economic growth.
  The annual rate of increase in house prices continues to be high––in the twelve months to May house prices increased by 13.7 percent, slightly below the rate to the previous month. With that, the effect of interest rate increases, steps by the Bank of Israel in the mortgage market, and steps by the Ministry of Finance regarding real estate taxation, together with the continued increase in building starts, are expected to affect housing prices during the coming year, although it is too early at this stage to see clear evidence of their effect on house prices in the data currently available.
  Central bank interest rates in the major advanced economies are still low, and are expected to remain so for a long time. Concern of a slowdown in US growth and the worsening of the debt crises in Europe led to expectations of a slowdown in the pace of interest rate increases in the US and Europe.
In the first half of the year the Bank of Israel raised the interest rate markedly. At the same time, steps were taken by the Bank of Israel and the Ministry of Finance in the housing market. In addition, the shekel appreciated in the last few months and there was a decline in commodity prices. The impact on inflation of these developments is expected to continue to be felt in the future. In light of these issues, and the marked increase of risks in the global economy, it was decided this month to leave the interest rate at its current level.
The Bank of Israel will continue to monitor developments in Israel's economy and the global economy and in the financial markets. The Bank 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 August 8, 2011.
The decision regarding the interest rate for September 2011 will be published at 17:30 on Monday, August 29, 2011.