Overview of economic developments and monetary policy in Israel

Good Afternoon to you all and thank you for attending this luncheon conference.

It is my pleasure to be here again, to discuss with you the latest economic developments in Israel and their impact on monetary policy.   I note that during the past few years the focus of the discussion was upon understanding the inflation dynamics in Israel, an economy that  was characterized by a low and sometimes very low rate of inflation against a backdrop of solid economic activity.  As we enter 2019, you will note that the focus of the discussion has somewhat shifted, with our recent concerns putting a bit more emphasis on the uncertainty surrounding the pace of real economic activity in addition to upholding our mandate of maintaining price stability.

So let me start indeed with the pace of economic development, updated to include the latest figures published yesterday by the Central Bureau of Statistics on GDP growth for the 4th of quarter of 2018, as well as the Bank of Israel’s Research Department staff forecast for 2019 and 2020 as was updated and published in the beginning of January.

 A first look shows a continued robust economy, which grew at 3.3% for the year – a similar pace to what we saw in the previous year, despite substantial quarterly volatility. The latter was in part related to a gradually implemented vehicle tax reform which triggers enlarged imports of cars just before every time the tax rise and of course a subsequent fall in those the following month – when those happen in different quarters, it gives rise to substantial quarterly volatility as you can see in Q1-2017 and Q2-2018. This volatility is felt particularly strongly in the private consumption figures as can be seen in slide 2. 

Private consumption as we know had been supported by a strong labor market as can be seen in slide no. 4, where both the rate of labor participation and employment had been steadily rising for a number of years, and now appear to have stabilized at this relatively high level.  Similarly, the Beveridge curve which shows the negative relationship between job vacancies and unemployment has stabilized at the upper left far corner of the graph, apparently no longer shifting to the left as we had witnessed for a number of years.  This seems to indicate that the pace of economic activity, which had greatly benefited from a continued enhancement of labor rate participation, is now reaching its long term potential, which is close to 3% a year.

 More recent monthly indicators support the robustness of the economy, as portrayed by the monthly State of the Economy Index, as well as by the Business Tendency Survey where demand constraints on production have remained low in all sectors surveyed. Nominal wages, particularly in the business sector, continue to rise at a brisk pace and the Health Tax receipt which is a good indication of overall wage payments in the economy, also shows no sign of relaxation of economic activity.

On the trade side, exports have continued to expand, led by exports of services, while exports of goods has stagnated for the past few years already. Note that the latter are more heavily tilted towards Europe which is recently showing signs of a renewed slowdown.

Activity in residential construction has continued to relent though the reduction in housing prices seems to have come to an end as the latest data showed a small rise in prices.

The fiscal stance was increasingly expansionary as the government deficit of 2.9% of GDP shows for  2018, thus given additional impetus to economic activity.  In fact, the fiscal stance at this point is no longer allowing for a debt/GDP ratio reduction, despite the robustness of economic activity, and the research Department of the BoI expects that under a "business as usual scenario" the deficit will either rise or stay at a similarly high level for the years to come, which will likely raise the Debt/GDP ratio gradually over the next few years.

So economic activity is still robust but now growing at its maximum potential.  Let us turn now to  the inflation environment.

As you know inflation in Israel has been lower than for most OECD countries for a number of years, though exhibiting a similar pattern of drop and then gradual rise over the past year or so. With the recent January figures published this past Friday, top line inflation stands at 1.2% for the past 12 months, within the 1%-3% target range for all but one of the past 8 months, albeit at a persistently low level. We use  various price indicators in our attempt to identify underlying inflation trend, which show that inflation excluding the volatile elements of energy, fruits and vegetables  and administrative shocks, is barely touching the bottom of the target range.  Short term inflation expectations have now been at the lower end of the target range for close to 9 consecutive months while medium to longer term expectations have remained within the range, though they have gradually moved below the mid point of the target range.

The decade long strengthening of the shekel seems to have abated during the past year, as can be seen by the relative stability of the nominal effective exchange rate on slide no. 23. For the past several months , the domestic financial institutions in Israel have been net sellers of the shekel, reversing their earlier trend of shekel accumulation exposure . More recently, foreign investors seem also to have stopped, or paused, their increase in shekel exposures.

Monetary policy responded to the steady though very gradual increase in the inflation environment with an increase in the interest rate in November 2018. That trend of gradual increase which had been observed during the summer and fall months, seemed to have paused towards the end of the year, along with the turbulence evident in the global financial markets. Accompanying that turbulence was also the downwardly updated forecast for the world economy for the year to come. The assessment made by the Monetary Committee in early January was that the path to the mid-point of the inflation range would be quite gradual  in light of those developments.  This guidance was meant to explain not only the interest rate decision of that month, but also the Committee's thoughts regarding the future path of interest rates.  As usual, the monetary response will  depend mostly on the assessment of the inflation dynamics in Israel as well as the performance of the Israeli economy at the time of each rate decision.