The Monetary Policy Report for the first half of 2018

  • Monetary policy: This report reviews the first five interest rate decisions made in 2018—on January 10, February 26, April 16, May 28, and July 9.  In these five decisions, the Monetary Committee left the interest rate at the historic low of 0.1 percent that was set in March 2015, continuing the accommodative monetary policy.  The decisions were set against the background of low inflation, accommodative monetary policy in most leading economies, the relative stability of the effective exchange rate of the shekel, moderation in the housing market, and improved economic efficiency in Israel and abroad.  As part of its forward guidance, the Monetary Committee declared that monetary policy would remain accommodative as long as necessary in order to entrench the inflation environment within the target range. During the reviewed period, the Bank of Israel continued to intervene in the foreign exchange market, and beginning in February, it intervened as part of the program to offset the effects of natural gas production.
  • Actual inflation and inflation expectations: During the reviewed period, most indicators pointed to a moderate increase in the inflation environment.  The annual rate of inflation has been in an upward trend since July 2017, and at the end of the reviewed period, it is 1.3 percent, having entered the target range for the first time in four years. Annual inflation minus energy, vegetables and fruit, and government-initiated price reductions also entered the target range at the end of the reviewed period.  The increase in the inflation environment was reflected in the increase in the rate of price changes in the most recent index readings[1] and in the fact that short- and medium-term inflation expectations reached the lower portion of the target range.  The assessment of the Monetary Committee members was that the low inflation environment in Israel does not reflect weakness in domestic demand, but mainly developments on the supply side.
  • Real domestic activity: The positive data on real activity received during the reviewed period led the Monetary Committee to the assessment that the economy is growing at close to its potential growth rate.  The data showed that the composition of growth continues to move toward greater balance, since it is tending more toward exports and less toward private consumption.  Economic strength was also reflected in the continuation of the tight labor market that has been evident the past two years, with a high level of job vacancies alongside a low unemployment rate, a record high employment rate, and a significant increase in wage levels, led by the business sector.
  • The exchange rate: During the reviewed period, the effective exchange rate of the shekel was at a relatively stable level, following stability during the second half of 2017 as well. Despite the stability in the past year, the assessment of most members of the Monetary Committee was that the real exchange rate remains over-appreciated, against the background of the continued and significant appreciation in recent years.
  • The housing market: After home prices increased for about a decade, the increases were halted from mid-2017 until January 2018, and housing prices declined during that period by a cumulative 2.5 percent.  Between February and April, prices were stable.  The assessment of the Monetary Committee was that the decline was a result of both moderating demand and the fact that supply expanded in recent years.
  • The global economy: During most of the reviewed period, global real economic activity and world trade continued to improve.  International economic organizations revised their forecasts of global real economic activity upward, but toward the middle of the period, risks to continued improvement increased due to the increasing concerns of a trade war between the US and China.  Inflation in most leading economies remains below 2 percent, but in the US it increased to above 2 percent.  The Fed increased the federal funds rate twice, to 1.75–2 percent, and the market expects two further increases until the end of 2018.  The ECB maintained its negative interest rate policy, but began reducing its quantitative easing, and even declared that at the beginning of 2019 it will stop the program completely.
  • Research Department staff forecast: According to the latest forecast by the Research Department, made in July 2018, GDP is expected to grow by 3.7 percent in 2018 and by 3.5 percent in 2019. Annual inflation is expected to remain within the target range during the second half of 2018, and to total 1.2 percent at the end of the year.  Inflation in 2019 is expected to be 1.5 percent. The forecast for the Bank of Israel interest rate remained unchanged in the first half of the year.  The rate is expected to remain at its current level until the third quarter of 2018, and to increase to 0.25 percent in the fourth quarter.

[1] Seasonally adjusted.