SummaryMonetary
policy: This report reviews monetary policy
during the first half of 2020 and the beginning of the second half of the year.
During the reviewed period, against the background of the major deterioration
in economic conditions as a result of the spread of the coronavirus and the
measures taken to halt it, the Monetary Committee put into operation a range of
tools in order to help deal with the crisis. The main measures taken were
intended to ensure the orderly functioning of the financial markets, to enhance
the passthrough from the Bank of Israel interest rate to the market interest
rates and to ease credit conditions.
Among other
things, the Committee implemented a program to purchase government and
corporate bonds in the secondary market, and a program for repo transactions with
institutional investors, and it also began to execute swap transaction in the
foreign exchange market, in addition to the purchase of foreign exchange that it
carries out from time to time. In addition, the Committee introduced a new
monetary instrument—long-term monetary loans to the banks in order to increase
the supply of credit to small businesses. In addition, it reduced the interest rate
by 0.15 percentage points to a level of 0.1 percent.
Domestic real
activity: During the reviewed period, there
was a marked deterioration in the real economy relative to the preceding half
year, in view of the onset of the pandemic and the containment measures adopted
by the government. The Bank of Israel’s assessments during the crisis pointed
to a decline in private consumption of around 30 percent relative to the precrisis
level and the shutdown of about 40 percent of the economy (in terms of GDP). Labor
market data published during the period indicate that more than 1 million
workers have applied for unemployment benefits. National Accounts data
published during the reviewed half year indicate that GDP during the first
quarter contracted less than initial estimates—by 6.8 percent in annual terms.
The decrease in GDP reflected a decline in most uses. Overall, the real developments
indicate that the Israeli economy is experiencing a recession that is unprecedented
in the State of Israel.
The inflation
environment: The decline in the inflation
environment, which began already prior to the Covid-19 crisis, continued also
during the crisis. The annual inflation rate remained below the lower bound of
the target range during the period being reviewed. One-year inflation
expectations declined from all sources—at first moderately, and since March,
sharply.
The Monetary
Committee assessed that the moderate decline in the inflation environment that occurred
at the beginning of the period (prior to the crisis) did not reflect weakness of
demand and that to a large extent it was influenced by the appreciation of the
shekel and by inflation components characterized by high volatility. At the
same time, the Committee was of the opinion that annual inflation would decline
before rising back to the vicinity of the lower bound of the target range. Due
to the spread of the pandemic, the Committee was of the view that there had
been a significant decline in the inflationary environment, and that the
decline incorporated two opposing trends: there was significant weakness in
demand, in Israel and abroad, which was expected to reduce prices; yet in
contrast, the adverse impact to the supply chain for various goods, was expected
to bring about a rise in prices from the supply side. The Committee felt that
the demand forces were dominant and that inflation would continue to fall.
Furthermore, the
Committee assessed that it was difficult to interpret the inflation data due to
problems in measuring goods and services that are temporarily unavailable due
to the restrictions on economic activity and in view of the changes in the
consumption patterns of households as a result of the crisis.
The exchange
rate: Until March, the shekel continued to
appreciate, and strengthened appreciably against most currencies. Following the
turmoil in the financial markets, a sharp depreciation occurred in the shekel
due to a shortage in dollar liquidity. As a result of the liquidity shortage,
the Bank of Israel began to execute swap transactions with the goal of
providing the required liquidity, thus leading to a drop in the shekel’s volatility
and an appreciation of the shekel. Since then, the shekel has returned to its
pre-crisis level.
Some of the
Committee members were of the opinion that if the shekel stabilizes at that level,
it will weigh on a recovery in exports and on the return of inflation to within
the target range. During most of the surveyed period, the Bank of Israel
continued to purchase foreign exchange, apart from during the period characterized
by a shortage in dollar liquidity and a rapid depreciation.
The global
economy: During the reviewed period, world trade
data declined sharply. International institutions and investment banks expected
global output to shrink, but were uncertain as to how much. The slowdown in
global activity and in world trade led to a decline in commodity prices—with
the price of oil reaching a new low relative to recent years and then partially
recovering. As a result of the spread of the pandemic worldwide, many countries
decided to adopt various monetary tools. Thus, many central banks initiated or
expanded asset purchase programs and reduced their policy rate. In parallel to the
monetary measures, many governments expanded their public expenditure and provided
support for the extending of credit to the business sector. At the time of the May
interest rate decision, the Monetary Committee continued to assess that the
risks to the global economy remained significant, and in particular, the risk
of a second wave of the epidemic.
Financial
market developments: With the onset of the global crisis and
the spread of the coronavirus worldwide, equity prices in Israel and worldwide declined
sharply. The nominal and real yields on government bonds for the medium and
long terms fell at the beginning of the half year, in line with the global
trend. As a result of the turmoil in the financial markets in March, yields
rose sharply but since then have corrected. According to the data as of the end
of the period being reviewed, they have returned to the vicinity of the levels
at the beginning of the year.
After the halt
in issuances in the corporate bond market in March, there was a recovery in
April and May. Bank credit grew during the crisis and the activity of
state-guaranteed credit funds led to a drop in the average interest rate
charged to small businesses. Prior to the interest rate reduction in April, and
throughout the period, expectations based on the Telbor market and the
professional forecasters’ projections reflected
a belief that policy would be even more accommodative in the future. In other
words, there is a positive probability of an interest rate reduction. According
to the most recent data, the expectation in the markets imply a high
probability of an additional reduction in the interest rate during the coming
year.
Fiscal policy: In the beginning of the half year, the deficit contracted due
to, among other things, the budget restraint resulting from operating under an interim
budget. Since then, the trend has reversed and the deficit has risen sharply,
as a result of the fiscal measures that were declared by the government
following the spread of the epidemic and the limitations that were imposed on
movement and economic activity. According to the Research Department’s staff
forecast, the deficit at the end of 2020 is expected to be roughly 12 percent
of GDP, an increase of about 8 percentage points relative to last year.
The Committee assessed
that the current level of the real interest rate enables the government to
finance the deficit on convenient terms. Similarly, as long as the deficit is a
direct result of the crisis, the financial markets will allow the government to
continue financing it, even if it grows somewhat as a result of the additional
policy steps to encouraging growth and productivity.
The housing
market: The data available to the Committee
members at the time of its decisions during the period did not yet reflect the
effect of the crisis. The data available at those points in time indicated that
activity was at a high level—home prices were increasing, alongside a high and
stable level of housing transactions. Looking forward, there was uncertainty
with regard to trends in the construction industry and in the housing market.
In the short term, a decrease in housing stock is possible due to the delays in
the issuing of permits, financing constraints, or a shortage in workforces and
raw materials. In contrast, a drop in demand is possible in view of the rise in
unemployment, uncertainty regarding employment, and the expectation of a drop
in the rate of increase in wages or even a decline in wages. The initial
estimate for April indicates a decline in the volume of transactions. A similar
picture emerges from mortgage data, which indicates a drop in mortgage closures
in April and May.
The Research
Department’s staff forecasts: The Research
Department published four forecasts during the period being reviewed in
parallel to the interest rate announcements – in January, April, May and July. The
forecast changed notably during the period, in view of the spread of the coronavirus
and the preventative measures adopted in Israel and worldwide.
In January, the
forecast was that inflation in 2020 would be 1 percent and would continue to
converge in the direction of the inflation target range in 2021. With respect
to economic activity, some slowing in growth was expected as a result of the
continuing slowdown in world trade and the reduction in the 2020 budget.
The forecast in
April was revised markedly downward in view of the spread of the pandemic. The
economy was expected to contract considerably in 2020 and subsequently was expected
to recover rapidly in 2021. Regarding the unemployment rate, it was expected to
gradually decline and would return to its low pre-crisis rate by the end of
2021. Inflation in 2020 was expected to be negative and in 2021 it was expected
to approach the lower bound of the inflation target range.
In the updated forecast
in May, the rapid removal of restrictions led to an upward revision of the
growth path for 2020—a smaller contraction, of 4.5 percent. There was a
downward revision regarding the recovery process, with a growth rate of 6.8
percent in 2021. The revised forecast for unemployment was 5.5 percent. As with
the other changes in economic activity, expected inflation for 2020 was revised
upward somewhat and for 2021 was revised downward.
In contrast,
the growth path in July was revised downward in view of the increase in the
rate of infection, which in turn led to a delay in the forecasted return of the
economy to routine. The May and July forecasts for the interest rate remained
unchanged (0.0–0.1 percent in another year).