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

26.03.2012
 
The Bank of Israel keeps the interest rate for April 2012 unchanged at 2.5 percent
 
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Inflation data: The Consumer Price Index (CPI) was unchanged in February, slightly below the average forecast, which was for an increase of 0.1 percent. On a seasonally adjusted basis, the CPI increased 0.3 percent, above the seasonal path consistent with achieving the inflation target. The rate of inflation over the past 12 months was 1.7 percent.
Inflation and interest rate forecasts: The average of forecasters' inflation predictions for the next twelve CPI readings continued to increase, and is currently 2.5 percent, compared with 2.3 percent last month. Inflation expectations for the next 12 CPI readings, based on CPI futures contracts offered over-the-counter by banks, were 2.5 percent on average this month, compared with 2 percent last month. The increase in expectations apparently derives from supply side factors, primarily worldwide energy prices. One year forward inflation expectations as calculated from the capital markets (break-even inflation) were 2.9 percent on average in March, a 0.3 percentage point 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 as well. Inflation expectations for the medium term were stable at 2.6 percent, and for longer terms declined by about 0.2 percentage points to 2.4 percent. Expectations for the Bank of Israel interest rate one year from now, based on the Telbor (Tel Aviv Inter-Bank Offered Rate) market, reflect expectations of an increase in the Bank of Israel interest rate to 2.7 percent, and expectations calculated from the makam yield curve were 2.6 percent. The average of forecasters' predictions of the interest rate in one year's time was 2.6 percent, compared with average projections of 2.4 percent last month. Forecasters project that the Bank of Israel interest rate will remain unchanged for the next three months.
Real economic activity: Economic indicators that became available this month support the assessment that the pace of growth is stabilizing at the level recorded in the fourth quarter of 2011, and concern of a further decline in the rate of GDP growth has eased. The Composite State of the Economy Indices for January and February indicated stability at a level of growth similar to that recorded in the fourth quarter of 2011. The components of the composite index which contributed to the rise in the index were manufacturing production, goods imports, and services exports. These were partially offset by declines in goods exports and the trade and services revenue index. The Central Bureau of Statistics monthly survey of business trends also indicates that the slowdown in the rate of growth is ending, with potential for some acceleration in growth in the coming months. The Research Department's index based on Google searches, which serves as an indicator of demand in the economy in the coming months, is positive, although it does not forecast significant acceleration in growth. The Purchasing Managers Index increased in February to 44 points, after a sharp drop in the previous month, with a positive change in most of its components. This level is still below 50, however, the level considered the boundary between contraction and expansion of activity.
The labor market: In the labor market a high level of employment and a low unemployment rate persists. The Labor Force Survey for the fourth quarter indicates a low unemployment rate of 5.4 percent, with stability in the participation rate. Despite the favorable unemployment figures, some slowdown can be seen in the labor market: the rate of increase in the number of employee posts has been on a downward trend since the second quarter of 2011. In December 2011, the rate of increase in employee posts, on an annual basis, was below 1.5 percent, compared with more than 4 percent in the beginning of 2011. The Central Bureau of Statistics Job Vacancy Survey indicates some decline in the number of job vacancies in February. Nominal wages increased 1 percent in October–December, compared with the preceding three months, and real wages increased 0.6 percent. Health tax receipts, which provide an indication of total wage payments, were 5 percent higher in February in nominal terms than in February 2011 (excluding the effect of legislative changes).
The Bank of Israel Research Department staff forecast: The Bank of Israel Research Department compiled its quarterly staff forecast this month. Projected GDP growth in 2012 was revised slightly upward, to 3.1 percent, and the forecast for 2013 is 3.5 percent. The Research Department forecasts an increase in the unemployment rate to 5.9 percent at the end of 2012. The new forecast projects an inflation rate of 2.6 percent over the next four quarters and an average interest rate in the first quarter of 2013 of 2.5 percent. The Research Department noted that the main risks to the forecast are a deterioration in the geopolitical situation and increases in energy prices, which would increase inflation and slow activity, and a worsening of the debt crisis in Europe, which would reduce inflation and also slow activity.
Budget data: Total tax receipts in the first two months of the year were NIS 1.3 billion above the seasonal path consistent with the tax revenues forecast in the budget, which the Ministry of Finance updated at the beginning of the year, and which is consistent with a deficit of 3.4 percent of GDP. The better-than-forecast receipts were due mainly to an exceptional one-time revenue in January. Net of that revenue, tax receipts are in line with the revised forecast. Trend figures (at constant prices, net of seasonal factors) indicate that direct tax receipts in February were essentially unchanged compared with the preceding month. The government's budget surplus since the beginning of the year reached NIS 3.3 billion, and net of the one-time revenues it is approximately in line with the revised deficit forecast.
The foreign exchange market: From the previous monetary policy discussion held on February 26, 2012, through March 23, 2012, the shekel appreciated against the dollar by about 0.9 percent, while other major currencies depreciated against the dollar by up to 3.25 percent. Against the euro, the shekel appreciated about 2.4 percent, while in trade against other currencies the euro moved in opposite directions. In terms of the nominal effective exchange rate the shekel appreciated by about 1.3 percent. The strengthening of the shekel this month followed a trend of depreciation evident in the last few months.
The capital and money markets: From the previous monetary policy discussion held on February 26, 2012, through March 23, 2012, the Tel Aviv 25 Index increased by 4 percent, against the background of the announcement by the Supervisor of Banks about increases in the capital ratios of the banks, to be implemented in the years ahead. The increases were less than expected by the banks and by the market. Following the announcement the bank shares index rose by 8 percent. The rise in the Tel Aviv 25 index may be seen against the background of the mixed trends evident in the leading share indices around the world, in comparison with which the Tel Aviv indices have been under-performing in the last few months. Yields increased in the government bond market, particularly in the unindexed segment, but also in the CPI-indexed segment along the entire yield curves. The yield differential between Israeli 10-year government bonds and equivalent 10-year US Treasury securities contracted by 21 basis points (b.p.) to 246 b.p., from 267 b.p. just before the previous monetary discussion; this was due to a sharper rise in yields in the US. Makam yields increased during the period along the entire curve to an average of 2.6 percent, so that the market essentially does not project an interest rate reduction in the coming year. Nonresident investors continued to exit from this channel, thus supporting the increase in yields. The trend of money market fund withdrawals continued this month as well, while corporate bond mutual funds attracted net new investments again this month, albeit at low levels. Israel's sovereign risk premium as measured by the five-year CDS spread widened slightly to 195 b.p., compared with 190 b.p. just before the previous interest rate decision. The Tel-Bond 20 and the Tel-Bond 40 Index increased by 0.5 percent. Tel-Bond yield gaps vis-?-vis government bonds narrowed this month, while those of holding company bonds remained around their high levels of a month ago.
The money supply: In the twelve months ending in February, the M1 monetary aggregate (cash held by the public and demand deposits) increased by 0.7 percent, and the M2 aggregate (M1 plus unindexed deposits of up to one year) increased by 9.1 percent.
Developments in the credit markets: The balance of outstanding debt of the business sector declined in January by 0.2 percent, to NIS 771 billion. The decline in the debt balance derived primarily from the appreciation of the shekel against the dollar, which reduced the shekel value of foreign currency debt. Outstanding credit to households increased by 0.1 percent, to NIS 365 billion. The balance of outstanding housing credit to households increased by 0.2 percent in January, to NIS 259 billion. Total mortgages granted in the twelve months ending in February was 2.3 percent lower than that advanced in the twelve months to January, continuing the decline from the peak level in May. Unindexed floating rate mortgages granted in February constituted 27.3 percent of total new mortgages. Interest rates on floating rate price-indexed and unindexed mortgages declined, while interest rates on fixed rate CPI-indexed mortgages were unchanged.
The housing market: The housing component of the CPI (representing rents), was unchanged in February. In the twelve months to February it increased by 4.6 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 December-January by 0.1 percent, the second consecutive increase after three months in which the cumulative decline was 1.4 percent. In the twelve months to January, home prices increased by 4.5 percent, continuing the marked slowdown from the rates recorded in previous months.
Activity in the construction industry continues to be strong. There were 43,648 building starts in the twelve months to November, compared with 43,537 in the twelve months to October, and the number of completions was 33,917 compared with the previous month's figure of 34,775. However, in the fourth quarter of 2011 there was some decline in building starts, and it reached about 40,000 units per year. The sharp increase in building starts that began at the end of 2009 has led to an increase in the number of homes for sale, and in recent months it reached the levels of 2003–07.
The moderation in the rate of increase in 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: US macroeconomic data generally continued to surprise on the upside, and appear even better compared with the eurozone economy. The US economy grew by 3 percent in the fourth quarter, the highest rate of increase since the second quarter of 2010, compared with a contraction of 0.3 percent in the eurozone. Employment figures, consumer confidence, retail sales, and production data in the US all indicate expansion. Investment house assessments are that the treaty for tightening fiscal discipline in Europe is expected to make the switch to future growth in Europe more difficult. Macroeconomic data in emerging markets are mixed, but continue to indicate a slowdown in their growth, with India and Brazil each reporting that their growth rate in the fourth quarter of 2011 was the lowest in two years, and China reduced its growth forecasts to 7.5 percent. The rate of inflation in the US and the eurozone was unchanged in February, and over the previous 12 months inflation was 2.9 percent in the US and 2.7 percent in the eurozone. With that, there are concerns of an increase in energy prices, which will increase inflation rates, a situation reflected in recent months by an increase in inflation expectations in the US and Germany. The Fed and ECB left their interest rates unchanged this month. The Fed announced that it intends to maintain its funds rate at its near-zero level at least until the end of 2014, although the market is pricing in an interest rate increase as early as in August 2013. The ECB adopted another monetary expansion plan, which includes injecting significant liquidity into banks in the eurozone.
The main considerations behind the decision
The decision to leave the interest rate for April 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:
  The CPI was unchanged in February. Inflation over the previous 12 months continues to settle firmly within the inflation target range, and is currently at 1.7 percent. Inflation expectations from various sources (forecasters, the Bank of Israel, CPI futures) for the next twelve months are within the inflation target range. However, in the past two months they have increased, and are currently in a range of 2.4–2.6 percent, mainly due to the increase in energy prices world wide, and the possibility of further increases in the months ahead.
  The indicators that became available this month indicate a stable rate of increase of activity at the levels recorded in the fourth quarter of 2011. Estimated expectations of economic activity have improved, and they indicate some improvement in the rate of growth. Against this background, the Research Department updated its forecasts for growth in 2012 to 3.1 percent, compared with its forecast published 3 months ago which projected 2.8 percent. The forecast for 2013 is for growth of 3.5 percent.
  Developments in the global economy and the international capital markets this month reduced the probability of significant deterioration in economic activity in Europe and the US in the near future. Most US macroeconomic data surprised on the upside, and the US economy grew by 3 percent in the fourth quarter. In contrast, in the eurozone there was contraction of 0.3 percent. Macro data in emerging countries were mixed, but continue to indicate a moderate slowdown in their growth.
  Interest rates in major economies remained 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 and ECB, maintained their interest rates unchanged this month, as expected. The Fed declared that it intends to maintain the federal funds rate at its near-zero level at least until the end of 2014. The ECB launched an additional monetary expansion program which includes injecting significant liquidity into eurozone banks.
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 April 9, 2012.
The decision regarding the interest rate for May 2012 will be published at 17:30 on Monday, April 23, 2012.