The Bank of Israel keeps the interest rate for March 2012 unchanged at 2.5 percent

27.02.2012
 
The Bank of Israel keeps the interest rate for March 2012 unchanged at 2.5 percent
 
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Background conditions
 
Inflation data: The Consumer Price Index (CPI) was unchanged in January; the average of the forecasts was for a decline of 0.1–0.2 percent. The rate of inflation over the past 12 months was 2 percent.
Inflation and interest rate forecasts: One year forward inflation expectations as calculated from the capital markets (break-even inflation) were 2.6 percent on average in February, a 0.3 percent increase from the previous month. With that, this series is affected by seasonal factors, due to a lack of continuous indexed bond series. Thus, the expectations estimate is apparently biased upward this month. Inflation expectations calculated from the capital markets for the medium term were 2.5 percent, and for longer terms were 2.6 percent—an average increase of about 0.1 to 0.2 percent from the previous month. Forecasters' inflation predictions for the next twelve CPI readings average 2.4 percent, an increase from their projections last month. Forecasters expect, on average, a cumulative increase of 1 percent over the next three CPI readings. Expectations for the Bank of Israel interest rate one year from now, based on the Telbor (Tel Aviv Inter-Bank Offered Rate) market, remained steady this month as well at 2.4 percent, and the average of forecasters' predictions of the interest rate in one year's time was 2.4 percent, compared with projections of 2.6 percent last month. Forecasters project that the Bank of Israel interest rate for March will remain unchanged.
Real economic activity: Although economic indicators that became available this month show a mixed trend, the general assessment is that in the fourth quarter and in January there was a continued slowdown in the rate of growth of activity and of demand. These indicators are consistent with the Bank of Israel forecast for growth of 2.8 percent in 2012. The first estimate of National Accounts figures for the fourth quarter (in annual terms) shows that GDP increased 3.2 percent, compared with 3.8 percent in the previous quarter; business sector product increased 3.3 percent, compared with 5 percent in the previous quarter, private consumption expenditure declined by 4 percent, compared with an increase of 0.2 percent in the previous quarter; fixed capital formation by industries declined by 3.1 percent, compared with an increase of 14.9 percent in the previous quarter; and exports declined 17.4 percent, compared with a decline of 7.7 percent in the previous quarter. The Composite State of the Economy Index increased 0.2 percent in January. An analysis of the various components of the index (manufacturing production, trade and services revenue, and imports of production inputs) in recent months indicates stabilization and even slight improvement. In contrast, goods exports declined 6.3 percent in January. VAT revenues from domestic production were stable, compared with a decline of 3.5 percent in the previous month. The Central Bureau of Statistics monthly survey of business trends and its consumer confidence indicator continued to be negative in January as well, though with some improvement. The Bank of Israel's Companies Survey for the fourth quarter indicates stability in the net balance of activity for the second consecutive quarter.
The labor market: Labor market data indicate a high level of employment and a low unemployment rate. The job vacancy rate, which reflects demand for employees, ranged from 2.5–3 percent. Nominal wages increased 1.4 percent in September–November, compared with the preceding three months, and real wages increased 1.1 percent. Health tax receipts, which provide an indication of total wage payments, were 5.1 percent higher in January in nominal terms than in January 2011 (excluding the effect of legislative changes), and despite an increase compared with December, there is still some moderation from the pace of increase in the beginning of 2011. New claims for unemployment benefits increased in December, continuing the trend of increase since the middle of 2011.
The Bank of Israel Research Department staff forecast: The Bank of Israel Research Department staff forecast compiled in December projects an inflation rate of 2.1 percent in 2012, and an average interest rate in the last quarter of 2012 of 2.2 percent. GDP growth in 2012 is projected to be 2.8 percent. The Research Department's assessment at the time of the forecast was that the housing component of the CPI (representing rents) will increase 4 percent in 2012. The Research Department noted that a continued increase in oil prices is expected to lead to an increase in inflation. Based on its projections, an increase of ten percent in oil prices will lead to a gradual increase of 0.3 percent in the CPI.
Budget data: Total tax receipts in January were NIS 2.9 billion above the seasonal path consistent with the tax revenues forecast in the budget. The better than forecast receipts were due mainly to one-time revenues from direct taxes. In light of the projected growth rate in 2012 (2.8 percent), which is lower than the growth rate used in constructing the budget (4 percent), and given the pace of tax receipts net of one-time revenues, then to the extent that government expenditure—despite recent expenditure commitments by the government—does not deviate from the ceiling set by law, the deficit in 2012 is expected to be 3.3 percent of GDP, above the deficit ceiling of 2 percent of GDP set at the end of 2010.
The foreign exchange market: From the previous monetary policy discussion held on January 22, 2012, through February 24, 2012, the shekel appreciated against the dollar by about 0.7 percent, a much more moderate pace than the trend in most other economies. The shekel depreciated about 2.7 percent against the euro. In terms of the nominal effective exchange rate the shekel depreciated by about 1.2 percent.
The capital and money markets: From the previous monetary policy discussion held on January 22, 2012, through February 24, 2012, the Tel Aviv 25 Index declined by 4.3 percent, in sharp contrast to the strong increases on stock market indices in advanced and emerging economies. The government bond market exhibited a mixed trend. Yields on unindexed government bonds increased by about 10 basis points (b.p.) for medium to long maturities, and yields on indexed bonds declined by about 25 b.p. for short terms, and with slight changes in other maturities.
The yield differential between Israeli 10-year government bonds and equivalent 10-year US Treasury securities widened moderately to 260 b.p. from 250 b.p. in the previous month. The interest rate reduction last month by the Bank of Israel, and the exit of nonresidents from makam, which continued this month, acted in opposite directions on makam yields. Makam yields decreased during the period by 5–10 b.p. along the entire curve, and the yield for one year was around 2.44 percent. The trend of money market fund withdrawals continued this month as well. However, corporate bond mutual funds, for the first time in a year, attracted net new investments, albeit at low levels. Israel's sovereign risk premium as measured by the five-year CDS spread narrowed slightly to 190 b.p., compared with 199 b.p. just before the previous interest rate decision. The Tel-Bond 20 Index increased by 0.7 percent, and the Tel-Bond 40 Index increased by 0.45 percent. Yield gaps widened this month, a trend which stood out primarily among lower rated companies.
The money supply: In the twelve months ending in January, the M1 monetary aggregate (cash held by the public and demand deposits) declined by 1.2 percent, and the M2 aggregate (M1 plus unindexed deposits of up to one year) increased by 10.9 percent.
Developments in the credit markets: The balance of outstanding debt of the business sector increased in December by 0.2 percent, to NIS 779 billion. Outstanding credit to households increased by 0.5 percent, to NIS 364 billion. The balance of outstanding housing credit to households increased by 0.3 percent in December, to NIS 258 billion. Housing credit extended in the twelve months ending in January was 2.1 percent lower than that advanced in the twelve months to December, continuing the decline from the peak level in May. The share of unindexed floating rate mortgages granted in January was 26.9 percent. Interest rates on price-indexed mortgages declined slightly, and interest rates on nominal mortgages were unchanged.
The housing market: The housing component of the CPI (representing rents), increased by 0.3 percent in January. In the twelve months to January it increased by 5 percent. Home prices, which are published in the Central Bureau of Statistics survey of home prices but are not included in the CPI, increased in November–December by 0.6 percent, the first increase after three months of decline in which the cumulative decline was 1.4 percent. In the twelve months to December, home prices increased by 6.1 percent, compared with a rate of 7.1 percent in the twelve months to November.
Activity in the construction industry continues to be strong. There were 43,535 building starts in the twelve months to November, compared with 43,221 in the twelve months to October, and the number of completions was 33,629 compared with the previous month's figure of 34,434. However, based on data from the Bank of Israel Companies Survey for the fourth quarter of 2011, construction companies report a sharp increase in the difficulty of selling apartments.
The moderation in the rate on increase of home prices in recent months 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. These moves, together with land marketing efforts by the Ministry of Construction and Housing and the Israel Land Administration, are expected to continue to have an effect in the future.
The global economy: Global macroeconomic data presented a mixed picture this month. World financial markets exhibited a positive trend. Macroeconomic data in the US which were published this month continue to be encouraging, particularly employment figures, sales and production indices, and credit figures. In emerging economies, the trend was mixed. In Europe and Japan, macro figures continued to indicate a recessionary environment, which is forecast to continue during the current quarter. The various austerity measures in Europe and the deterioration in credit conditions are liable to exacerbate this path. This month, the aid plan for Greece was approved. The IMF revised its 2012 and 2013 world growth forecasts downward, to 3.3 percent and 3.9 percent, respectively, from 4.0 percent and 4.5 percent, respectively, in its previous forecast. Additionally, the IMF revised downward its forecast for world trade growth in 2012 to 3.8 percent, from 5.8 percent in its previous forecast. IMF economists point out risks to the continuation of the global economic recovery, chief among them the debt crisis in Europe. Central banks increased their activity in capital markets this month. World wide inflation remains restrained, though the continued increase of commodity prices, particularly oil, is liable to make continued recovery in economic activity difficult. Against the background of all these factors, the Bank of England and Bank of Japan took additional expansionary steps. In the next few days, the ECB is expected to adopt another LTRO plan to increase long term liquidity.
   
The main considerations behind the decision
   
The decision to leave the interest rate for March 2012 unchanged at 2.5 percent is consistent with an interest rate policy that is intended to entrench the inflation rate within the price stability target of 1–3 percent 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, monetary policies of major central banks, and developments in the exchange rate of the shekel.
The following were the main considerations underlying the decision:
  Inflation expectations from various sources, for the next twelve months and for longer terms, are within the inflation target range. However, in the past month they have increased by approximately 0.2 percentage points, to around 2.5 percent. Actual inflation over the previous twelve months continues to settle firmly within the inflation target range.
  The indicators that became available this month support the assessment that in the fourth quarter and in January the slowdown in the rate of growth of activity continued. With that, some monthly indicators (such as the manufacturing production index, trade and services revenue index, and the index of imports of production inputs) point to slight improvement in recent months. Indicators of real economic activity are consistent with the Bank of Israel forecast of growth of about 2.8 percent in 2012.
  Data on global economic activity which became available this month presented a mixed picture, and financial markets exhibited some increase in optimism. In the US, relatively encouraging data were published. In emerging economies, data were mixed; in Europe and Japan, macro figures continued to indicate a recessionary environment, which is expected to continue in the current quarter as well. About a month ago, the IMF revised downward its 2012 and 2013 global growth and world trade forecasts, with its economists emphasizing the developing recession in Europe.
  Interest rates in major economies are low, and markets are not pricing in an increase in the interest rate this year by any of the central banks of large advanced economies. The Fed, it will be recalled, declared that the federal funds rate will remain at its near-zero level at least until the middle of 2014. The Bank of England and the ECB continued their efforts to increase liquidity.
The Bank of Israel will continue to monitor developments in Israel's economy and the global economy and in 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 March 12, 2012.
The decision regarding the interest rate for April 2012 will be published at 17:30 on Monday, March 26, 2012.