The Monetary Policy Report for the first half of 2019


SUMMARY

Monetary policy: This report reviews the monetary policy in the first half of 2019 and in the beginning of the second half of 2019.[1] In the first half of 2019, the Monetary Committee kept the interest rate unchanged, after increasing it to 0.25 percent at the end of the previous half year. The Committee’s decisions kept the forward guidance, which stated that the Committee assesses that the rising path of the interest rate in the future will be gradual and cautious, in a manner that supports a process at the end of which inflation will stabilize around the midpoint of the target range, and that supports economic activity. In the period reviewed, the Bank of Israel bought a small amount of foreign exchange—$86 million.

The inflation environment: The 1-year inflation rate was slightly above the lower bound of the target range during the entire reviewed period (the CPI for January through May), similar to its level in most months in the previous half year, and one-year inflation expectations, based on most sources, were as well. Inflation expectations for medium and long terms remained well entrenched within the target range throughout the half year. With regard to the inflation environment, the Monetary Committee members noted that for a notable period of time there had not been a significant change in it. Inflation in nontradable goods prices (an approximation of the domestic component of inflation) was above 2 percent throughout the half year, and the inflation rate in tradables became slightly negative in some of the months, as opposed to the previous half year, but afterwards it returned to being positive. After the end of the period reviewed, the CPI for June, which was lower than expected, was published, and the 12-month inflation rate in June was slightly below the lower bound of the target range.

Real domestic activity: The data on real activity published during the reviewed period supported the assessment that activity is converging to growth at a pace slightly lower than its potential of approximately 3 percent, and that data on the previous half year indicated a transitory slowing in the second and third quarters of 2018 that derived from supply constraints. This assessment is supported mainly by the tight labor market and the continued increase in wages, primarily in the business sector.

Fiscal policy: During the course of the half year reviewed, the marked uncertainty in the fiscal sphere was discussed, among other things in view of the general elections that were held during the period: this derived from the possible ramifications of the coalition-forming negotiations, from the steps that the future government might take in order to deal with the expected deficit and from their possible effects on economic activity and on the inflationary path. In any case, the fiscal uncertainty is expected, in the Committee’s assessment, to continue for some time.

Capital market developments: Telbor market-based expectations with regard to an interest rate increase declined for all ranges during the course of the half hear, and they reflect a relatively high probability of no change in the interest rate in the coming year, in contrast to forecasters’ assessments and the Research Department’s staff forecast. In the half year reviewed, a downward trend in nominal and real yields in Israel for all ranges was seen, similar to their declines worldwide.

The housing market: Data published toward the end of the period reviewed[2] indicated an increase in home prices of 1 percent in the past 12 months, following a year over year decline of more than 2 percent in some months of the previous half year. This is in parallel to the marked increase in the number of transactions. Despite the increase in home prices, the Committee members agreed that it is still too early to assess if the trend of rising prices is renewing or if their decline will continue. There has been a continued moderate rising trend in new mortgage volume since the end of 2017, against the background of a slight decline in the weighted real interest rate on mortgages, which started in the beginning of 2019.

The global economy: The Committee discussed the global economy—the moderation of activity, the uncertainty and the risks, as well as the downward revision of growth forecasts and the expected change in the interest rate path and in monetary policy worldwide. In the US, a lower interest rate path than before, and even an interest rate reduction, is expected, and in Europe, the expected date of the beginning of raising the interest rate was deferred. The Committee members assessed that the decline in world trade is expected to continue to impact on activity in Israel. The Committee discussed additional risk factors that impact on the global economy, including the possible US-China trade agreement and the uncertainty regarding Brexit.

The shekel exchange rate: During the half-year reviewed, the shekel strengthened markedly against major currencies, after it had depreciated in the fourth quarter of 2018. From the beginning of the half year, the shekel strengthened in terms of the nominal effective exchange rate, the dollar, and the euro; it appreciated by 5.4 percent in nominal effective exchange rate terms. The Committee members noted that the appreciation is the main factor delaying the continued increase of the inflation rate toward the midpoint of the target.

Research Department staff forecast: The Research Department’s staff forecast did not change markedly during the period reviewed. Based on the forecast compiled by the Research Department and published with the interest rate decision on July 8, 2019, GDP is expected to grow by 3.1 percent in 2019 and by 3.5 percent in 2020, a downward revision of 0.3 percentage points for 2019 (compared with the forecast compiled in January 2019). Inflation is expected to be 1.6 percent in 2019 (an upward revision of 0.3 percentage points for 2019 vis-à-vis the forecast in January) and 1.6 percent in 2020 (a downward revision of 0.2 percentage points for 2020 vis-à-vis the forecast in January). According to the forecast, the Bank of Israel interest rate is expected to increase to 0.5 percent toward the end of the third quarter of 2019 and to continue to increase gradually to 1 percent by the end of 2020 (a downward revision of 0.25 percentage points for 2020, compared with the forecast compiled in January 2019). Since the publication of the forecast, there were two developments in relatively significant parameters that impact on it: the CPI for June surprised to the downside, and there was a slight increase in the probability ascribed by the markets to monetary accommodation soon in the US.



[1] Decisions in 2019 were reached on February 25, April 8, May 20, and July 8.

[2]  Home Prices Survey data for March-April 2019.