Monetary policy report for the second half of 2017

15/02/2018
All Press Releases In Subject:
Monetary Policy and Inflation
SUMMARY
Monetary policy: In the second half of 2017, the Monetary Committee left unchanged the interest rate set in March 2015—0.1 percent—because the inflation environment ranged below its target rate. In its forward guidance, the Committee declared that the monetary policy would remain accommodative for as long as needed to entrench the inflation environment within the target range. Against the backdrop of the depreciation that occurred in the beginning of the period under review, the Bank of Israel reduced its intervention in the foreign exchange market. After some appreciation during the course of the period, the shekel appreciated further toward the end of the period under review and afterwards, and in January 2018 the Bank of Israel expanded its intervention.
Actual inflation and inflation expectations: Over the course of the year, the annual rate of inflation remained below the inflation target, and reached 0.4 percent at the end of the year. For the first time since 2014, inflation was positive for most months of the year, although its development over the year was uneven. Inflation ranged below the target as a result of the continuous appreciation of the shekel prior to the period under review as well, government action to reduce the cost of living, increased competition in the economy, low global inflation, and despite rising wages and the strength of the labor market. Inflation expectations for a period of up to two years remained below the lower bound of the inflation target range, and forward inflation expectations for the third year (years 2–3) ranged around the lower bound and rose slightly at the year end. Longer term inflation expectations remained firmly anchored within the target range.
Real domestic activity: The data available to the Monetary Committee in the second half of 2017 indicated that growth increased at a more moderate pace this year, leading to the assessment that the rate is consistent with the economy’s potential growth. Committee members believed that the moderation in the growth rate primarily reflects limitations on the supply side resulting from the full employment environment. After the weakness in exports seen in recent years, and particularly in goods exports, they recovered at the beginning of the second half of the year, led by services exports. However, the recovery halted later on, and private consumption returned to being the main component of growth.
The exchange rate: After a marked appreciation in the nominal effective exchange rate of the shekel in the previous half-year period, there was a moderate depreciation of 1 percent in the second half of the year (December average vs. June average). The development of the exchange rate was, however, uneven in this period: a considerable depreciation occurred until August, primarily against the euro, which was then followed by an appreciation of the shekel. In the beginning of 2018, through February 9th, the shekel depreciated by approximately 2.5 percent compared to its average level in December 2017.
The housing market: In the second half of 2017 (until November), the rate of increase in home prices slowed. Alongside a decline in the number of transactions, there was also a decrease in building starts, though the supply is expected to increase in the future, as the number of building permits increased. Monthly mortgage volume stabilized after a sharp decline, and as a result, the balance of housing credit expanded at a more moderate rate compared with the previous year.
The global economy: In the period under review, world trade as well as growth figures for most economies continued to improve, and growth forecasts were revised upward. The US Federal Reserve is raising the federal funds rate gradually, with an increase in December as well. The ECB kept the interest rate at -0.4 percent and announced that it would reduce the scope of its monthly bond purchases beginning in January 2018 but would extend the period during which it makes the purchases. Other central banks shifted their monetary policies to a less accommodative stance, although the monetary environment remains extremely accommodative., inflation remained below target in most major economies, although in the period under review the growth rate of global commodity and oil prices accelerated .
The financial markets: Between July and November (inclusive), domestic share indices were stable, mainly underperforming compared to leading global indices. This is primarily due to the underperformance of the major chemical and pharmaceutical companies, which are heavily represented in Israeli indices. In December, the domestic situation reversed, and for the second half of 2017 overall, domestic share indices rose only slightly less than US and European indices. In the beginning of February 2018, after the period reviewed in this report, there were sharp declines in equity indices in Israel and abroad. In the second half of 2017, nominal yield curves shifted downward for medium and long-term maturities. In 2017, the flood in issues of nonfinancial public companies continued and in the period under review spreads between corporate and government bonds declined to their lowest level since 2007. In the second half of 2017, tax revenues exceeded forecasts and ultimately allowed the government to repay a portion of its debt early, and to reduce the scope of its debt raising.
Research Department staff forecast: According to the staff forecast published by the Research Department in January 2018, GDP is expected to grow by 3.4 percent in 2018 and by 3.5 percent in 2019. Inflation is expected to converge to within the target range during 2018 and reach 1.1 percent at the end of the year. The Bank of Israel interest rate is expected to remain at its current level until the third quarter of 2018, and rise in the fourth quarter.