The Bank of Israel leaves the interest rate for January 2012 unchanged at 2.75 percent

26.12.2011
 
The Bank of Israel leaves the interest rate for January 2012 unchanged at 2.75 percent
 
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Background conditions
Inflation data: The Consumer Price Index (CPI) declined by 0.1 percent in November, in contrast with forecasts, which had predicted an increase of 0.1 percent. The unexpected change was due mainly to the fall in the housing component. The rate of inflation over the past 12 months, as measured by the change in the CPI, continued to settle more firmly within the target range (1–3 percent per year), and is now 2.6 percent.
Inflation and interest rate forecasts: One year forward inflation expectations as calculated from the capital markets rose at the beginning of the month to almost 2 percent. Inflation expectations (break-even inflation) for the medium term increased slightly, and those for the long term declined, and both are currently 2.5 percent. Forecasters' inflation predictions for the next twelve CPI readings average 2.2 percent, compared with 2.3 percent last month. Expectations of the Bank of Israel interest rate one year from now, based on the Telbor (Tel Aviv Inter-Bank Offered Rate) market, dropped to 2.35 percent from 2.7 percent in the previous month, and the average of forecasters' predictions of the interest rate in one year's time declined to 2.3 percent, from 2.8 percent last month. About half of the forecasters expect the Bank of Israel to leave the interest rate for January 2012 unchanged, and half expect the Bank to cut the rate by 0.25 percentage points.
Real economic activity: Economic indicators that became available this month show a continued slowdown in the rate of growth. The rate of increase of domestic demand slowed, and is close to the long-term trend. Exports, however, remain low, and in light of the reduced forecasts of world trade are not expected to return to the high rates of increase evident till the first quarter of 2011. In the third quarter of 2011 the current account of the balance of payments recorded a surplus of $0.6 billion, in essence the result of a decline in imports and in nonresidents' income from their investments in Israel. Direct tax revenues were 6 percent lower in November, in real terms, than in November 2010, while indirect tax revenues were 6 percent higher, in real terms, than in November 2010. The Composite State-of-the-Economy Index rose in November by 0.2 percent, indicating continued expansion of economic activity, but at a slower pace than in the third quarter. The most notable item in the index was the high-tech component of manufacturing production, which increased by 4.6 percent. The consumer confidence indices and the trends survey reflect a high degree of uncertainty and pessimism with regard to the level of activity in the future.
The labor market: Labor market data indicate a high level of employment and a low unemployment rate. According to the CBS Labor Force Survey for the third quarter, the unemployment rate remained virtually unchanged at 5.6 percent, the rate of participation in the labor force was steady at 57.4 percent, and the rate of employment was stable at 54.2 percent. In the third quarter the number of employed persons increased in most industries in the business sector, while the number in the public sector fell. The number of full-time employees increased, and the number of part-time employees declined. The nominal wage increased by 0.8 percent in July–September compared with the previous three months, and the real wage increased by 0.4 percent. Health tax receipts, which provide an indication of wage payments, were 5.5 percent higher in November in nominal terms than in November 2010 (excluding the effect of legislative changes).
The Bank of Israel Research Department staff forecast: The basic forecast of the Bank of Israel Research Department was updated this month, and the forecast of inflation in 2012 now stands at 2.1 percent, and that of the interest rate in the last quarter of 2012 is 2.2 percent. GDP growth in 2011 is expected to be 4.8 percent. The growth forecast for 2012 was revised downwards, to 2.8 percent, compared with the previous forecast of 3.2 percent. The forecast was lowered due to the slowdown reflected in published data on Israel's economy, mainly National Accounts figures for the third quarter, and to the expectation of a global slowdown, against the background of the debt crises in Europe and their implications.
Budget data: Government domestic revenues for the year to November (inclusive) were 2.7 percent lower than the seasonal path of the budget forecast, primarily due to a continued slowdown in indirect tax receipts, which began in April. The overall government deficit (excluding net credit) in the year to date was NIS 15.1 billion, compared with a deficit of NIS 17.1 billion in the corresponding period in 2010. Government activity so far indicates that tax revenues will be about 2 percent lower than the budget forecast, and the budget deficit for the year 2011 will be above the deficit ceiling set by law of 3 percent of GDP.
The foreign exchange market: From the previous monetary policy discussion held on November 27, to December 23, the exchange rate of the shekel against the dollar was almost unchanged (the shekel appreciated by 0.1 percent against the dollar), in contrast with most major currencies that strengthened against the dollar; the shekel appreciated by 1.9 percent against the euro. In terms of the nominal effective exchange rate the shekel strengthened by about 0.6 percent.
The capital and money markets: From the previous monetary policy discussion held on November 27, to December 23, the Tel Aviv 25 Index rose by 7.3 percent, similar to stock market indices in advanced and emerging economies. In the government bond market rates declined along the entire curve. Yields on unindexed government bonds dropped by 15–25 basis points (b.p.) along the entire curve, and yields on indexed bonds also declined by 15–25 b.p. for medium maturities (5–10 years), and fell more moderately, by 5–15 b.p., for short and long maturities. The yield gap between Israeli 10-year government bonds and equivalent 10-year US Treasury securities narrowed to about 258 b.p., from 280 b.p. in the previous month. Makam yields decreased by 12–27 b.p. along the entire curve, and the yield for one year decreased from 2.68 percent to 2.56 percent, this against the background of expectations of further cuts in the interest rate by the Bank of Israel and despite the continued exit of nonresidents from makam. Withdrawals from mutual funds specializing in corporate bonds continued this month, although at a slower pace than in the previous month. Israel's sovereign risk premium as measured by the five-year CDS spread fell this month to 198 b.p. from 215 b.p. last month. The Tel-Bond 20 Index rose by 0.2 percent, and the Tel-Bond 40 Index by 0.3 percent.
The money supply: In the twelve months ending in November, the M1 monetary aggregate (cash held by the public and demand deposits) increased by 2 percent, and the M2 aggregate (M1 plus unindexed deposits of up to one year) increased by 10.4 percent.
Developments in the credit markets: The balance of outstanding debt of the business sector decreased in October by 1.7 percent, to NIS 767 billion. Outstanding credit to households declined by 0.2 percent, to NIS 360 billion. Of the credit to households, the balance of outstanding housing credit increased by 9.77 percent in the twelve months to October, to NIS 256 billion, compared with an increase of 11.3 percent in the twelve months to September. Housing credit advanced in the twelve months to November was 3.6 percent lower than that advanced in the twelve months to October, continuing the decline from the peak level in May. The share of unindexed floating rate mortgages granted in November was 26.6 percent. Interest rates on mortgages of all types remained basically unchanged.
The housing market: Housing prices (rental rates), which are included in the CPI, declined by 0.7 percent in November. In the twelve months to November they increased by 5.5 percent, compared with an increase of 6.3 percent in the twelve months to October; according to the updated Research Department forecast, in the next twelve months they are expected to increase by about 4 percent. Home prices, which are published in the Central Bureau of Statistics survey of home prices but are not included in the CPI, declined in September–October by 0.9 percent, the second decline in succession. These decreases in home prices came after a long period of price increases that started in December 2008. This month too the annual rate of increase in home prices moderated: in the twelve months to October home prices increased at a rate of 8.6 percent, compared with a rate of 10.5 percent in the twelve months to September, and rates of increase of about 20 percent in 2010.
Activity in the construction industry continues to be strong. There were 43,058 building starts in the twelve months to September, and the number of completions was 33,583, slightly lower than the numbers in the previous month. The number of homes available for sale continued to increase, and in September–November was on average 11.5 percent higher than in the three preceding months (original data).
The moderation in the rate on increase of home prices comes against the background of the continued increase in the number of building starts, the lagged 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. The effect of these moves is expected to continue and be evident going forward.
The global economy: Most data on economic activity in Europe are consistent with assessments that a recession will start in the eurozone during 2012. In contrast, US data continue to indicate an improvement in the economic situation. The European Central Bank (ECB) assesses that eurozone growth will be 0.3 percent in 2012, and 1.3 percent in 2013. The investment houses are more pessimistic, and predict negative growth of 0.7 percent in 2012, and global growth of 2.9 percent, compared with the previous forecast of 3.2 percent. The rating agencies warned about a possible downgrading of the rating of core European countries, including Germany. Signs of a slowdown in growth are evident also in several leading emerging countries, and forecasts for next year have been revised down. Moody's downgraded Belgium's sovereign credit rating, and three rating agencies downgraded the ratings of many banks, mainly in Europe and the US. Central banks around the world are taking steps to increase liquidity. The ECB announced that it would supply unlimited loans (collateralized) to banks for periods of up to three years. The Fed and five other central banks announced coordinated measures to reduce the interest rate in their dollar swap lines. Eurozone inflation is expected to be 2.7 percent in 2011, and 2 percent in 2012. The ECB lowered its interest rate by 0.25 percentage points for the second successive month, to 1 percent. Central banks in other countries also cut their interest rates, against the background of the global economic situation.
The main considerations behind the decision
The decision to leave the interest rate unchanged at 2.75 percent for January 2012 following the cut in the rate last month is consistent with the interest rate policy that is intended to entrench the inflation rate within the price stability target of 1–3 percent inflation a year over the next twelve months, and to support growth while maintaining financial stability. The path of the interest rate in the future depends on developments in the inflation environment, growth in Israel, the global economy, the monetary policies of major central banks, and developments in the exchange rate of the shekel.
  Inflation forecasts for the next twelve months––those calculated from the capital market, those of the forecasters and that of the Bank of Israel––are all close to the midpoint of the target inflation range. Actual inflation over the last twelve months is continuing to settle more firmly within the target inflation range.
  Indicators of economic activity in Israel continue to support the assessment that the economy is still expanding, although more slowly than at the beginning of the year and during last year. According to Bank of Israel assessments, the economy is expected to grow in 2012 at a rate of 2.8 percent. Most of the slowdown in growth derives from the weakness of exports, against the background of the weakness in the global economy; a moderation in domestic demand is also evident.
  Against the background of measures taken by the ECB this month, financial markets around the world improved somewhat. In the US, economic data continue to indicate an improvement in the economic situation. Data on economic activity in Europe, however, support the assessment that a recession is likely to start in the eurozone in the course of 2012. Several leading emerging countries are also showing signs of a slowdown in growth. Uncertainty regarding developments in the global economy remains high, and this impacts on the level of uncertainty regarding economic developments in Israel.
  The persistent negative trends in Europe led to another cut in the ECB interest rate, following the cut last month. The ECB also took steps to increase liquidity in the banks significantly. Other countries also cut their interest rates. The markets are not pricing in an increase in the interest rate in the coming year in any of the central banks of the large advanced economies. The Fed, it will be recalled, declared that its interest rate will remain at a near-zero level till mid-2013 at least. The Fed continues with its quantitative easing measures.
The Bank of Israel emphasizes that the current level of the interest rate helps to support the level of domestic economic activity and exports, and to keep inflation within the target range, and at the same time leaves the Bank room to react to developments in the global and domestic economy.
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 tools 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 asset markets.
The minutes of the discussions prior to the above interest rate decision will be published on January 9, 2012.
The decision regarding the interest rate for February 2012 will be published at 17:30 on Monday, January 23, 2012.