The Monetary Committee decides on August 28, 2019 to keep the interest rate unchanged at 0.25 percent

  • Since the previous interest rate decision, the inflation environment has shifted downward. The CPI readings for June and July were markedly lower than expected, and the inflation rate in the past 12 months is 0.5 percent. Inflation excluding energy and fruits and vegetables is 0.9 percent. Most of the negative contribution to the CPI is from the fruit and vegetables component, which is highly volatile, and from components affected by the appreciation of the shekel and the decline in energy prices. Short- and medium-term inflation expectations declined, with one-year expectations ranging around the lower bound of the target range, but long-term expectations remained anchored near the midpoint of the target range.
  • The shekel strengthened by 3 percent in terms of the nominal effective exchange rate since the previous interest rate decision, and by 8.7 percent since the beginning of the year. If the appreciation persists, it will be harder for a more extended period to return inflation to the target range.
  • Economic activity continues to grow at close to its potential rate, and thus far it seems that activity in Israel is not being adversely affected by the negative global sentiment. Private consumption excluding durable goods and public consumption drove growth in the second quarter, and the trend of expansion that has characterized exports in the past two years continued, led by services exports. Initial data for the third quarter support the assessment that growth is continuing at around the potential rate. The labor market remains tight.
  • The risks to the global economy have become more severe since the last interest rate decision, mainly in view of the worsening "trade war". Interest rates were lowered in the US and other economies, and further reductions are expected. In Europe, further monetary accommodation is expected.

 

The Monetary Committee's assessment is that in view of the turnaround in the inflation environment in Israel and in the monetary policies of major central banks, the slowing in the global economy, and the continued appreciation of the shekel, the interest rate will not be increased for an extended period. Moreover, if necessary, the Committee will take additional steps toward making monetary policy even more accommodative in order to support a process at the end of which inflation will stabilize around the midpoint of the target range, and to support economic activity. The Bank of Israel continues to monitor developments in inflation, the real economy, fiscal policy, the financial markets, and the global economy, and will act to attain the monetary policy targets in accordance with such developments.

 

For the file of figures accompanying this notice, click here.

Graphs and data

 

Since the last interest rate decision, the inflation environment has shifted downward. After most index readings since the beginning of the year surprised to the upside, the readings for June and July were markedly lower than expected. Inflation in the past 12 months was 0.5 percent (compared with 1.5 percent at the time of the previous interest rate decision) (Figure 1 in the attached file of figures), while inflation excluding energy and fruit and vegetables was 0.9 percent (1.1 percent at the time of the previous interest rate decision) (Figure 2). Most of the negative contribution to the CPI came from the highly volatile fruit and vegetables component, the effect of which is felt in the inflation of nontradable goods prices. There was also a negative contribution from declines in the cost of travel abroad and of private vehicle maintenance—items that were apparently impacted by the cumulative appreciation of the shekel since the beginning of the year and the decline in energy prices—which led to negative inflation in the prices of tradable goods. In view of the decline in inflation and the appreciation of the shekel, short- and medium-term inflation expectations also declined. A further decline in the year over year inflation rate is expected over the coming months, one-year expectations are close to the lower bound of the target range (Figure 4), and there was a decline in forward expectations up to three years. Long-term expectations remained anchored near the midpoint of the target range. (Figure 5). Since the previous interest rate decision, the exchange rate has been volatile, with the shekel strengthening by 3 percent in terms of the nominal effective exchange rate since the last interest rate decision, and by 8.7 percent since the beginning of the year (Figure 6). To the extent that the appreciation persists, it will be harder for a more extended period to return inflation to the target range.

 

Economic activity continues to grow at near its potential rate (Figure 11), and so far it seems that activity in Israel is not being adversely affected by the negative global sentiment. However, uncertainty regarding the measures to be taken by the government to reduce the deficit following the elections is leading to increased uncertainty about developments in the domestic economy. National Accounts data for the second quarter were affected by volatility in vehicle imports (Figure 12). GDP grew by 1 percent, but according to Research Department assessments, the growth rate net of this effect was above the potential rate. Growth was driven by private consumption excluding durables and by public consumption, both of which grew by more than 7 percent. The trend of expansion that has characterized exports in the past two years continues, led by services exports, as total exports (excluding diamonds and startups) increased by 4.6 percent. The Central Bureau of Statistics Business Tendency Survey indicates that there is no significant deterioration in the profitability of exports (Figure 16). Investment in residential construction seems to be recovering in 2019, after having contracted in the previous year. Initial third-quarter indicators (such as the Composite State of the Economy Index and the Business Tendency Survey; Figure 14) support the assessment that the economy is continuing to grow at around its potential rate. The labor market remains tight—the unemployment rate continued to decline, and the latest data on the employment and participation rates show they declined slightly but remain high. Wage increases are continuing, led by the business sector. The job vacancy rate has been declining moderately for several months, but remains high.

 

Equity indices in Israel declined since the previous interest rate decision, in parallel to global markets. Similar to global yields, medium- and long-term government bond yields declined sharply and eased financial conditions in the economy. For example, since the beginning of the year, the 10-year yield declined by 1.3 percentage points (Figure 7). Yield spreads between corporate bonds in Israel and comparable government bonds increased slightly, after having declined since the beginning of the year.

 

In recent months, home prices increased moderately: The increase in the past year is approximately 1.4 percent, while rents continue to rise. The number of purchases grew, led by first home buyers. Mortgage volume continued to expand, and mortgage interest rates continued to decline in view of the decline in government bond yields.

 

The risks to the global economy became more severe since the last interest rate decision, mainly in view of the intensifying "trade war". In July, even before the intensification of the "trade war", the IMF revised its 2019 global growth and world trade forecasts downward (Figure 20). The deterioration in world trade continues (Figure 21). In the financial markets, equity indices declined (Figure 26), and government bond yields declined sharply, in view of the actual and expected changes in monetary policy in various economies (Figure 25). In the US, the Federal Reserve lowered the federal funds rate by 0.25 percentage points, and assessments in the markets are that the interest rate will continue to decline this year. Growth in the second quarter was lower than in the first quarter, but higher than expected, and inflation is slightly below the target. In Europe, there was a slowdown in growth, and industrial production continues to contract, particularly in Germany and Italy, and inflation remained low. The ECB left its interest rate unchanged, but indicated that additional accommodative measures are expected. In Japan, growth was higher than expected in the second quarter, supported by domestic consumption and investments, and despite a decline in exports in view of the slowdown of activity in China. Growth in China continued to moderate. Manufacturing exports grew by a very low rate, and there is a continued slowdown in retail sales and exports. Oil prices declined since the previous interest rate decision, in view of the continued weakness in demand (Figure 23).

 

 

 

The minutes of the monetary discussions prior to this interest rate decision will be published on September 11, 2019. The next decision regarding the interest rate will be published at 16:00 on Monday, October 7, 2019, followed by a press briefing by the Governor.