Monetary Policy Report 2014 - First Half

All Press Releases In Subject:
Monetary Policy and Inflation
Monetary Policy Report 2014 - First Half -PDF File



·         Monetary and macroprudential policy: During the first half of 2014, the Monetary Committee reduced the interest rate, for March, by 0.25 percentage points, to 0.75 percent. During this period, the Bank of Israel also continued its foreign currency purchases, which totaled about $4.15 billion, of which about $1.75 billion was part of the program to offset the current account effects due to natural gas production. Despite the risks implicit in a low interest rate environment, the Committee members assessed that no significant financial imbalance is developing. In the view of the members of the Committee, the main financial risk exists in the housing market, and the steps taken by the Supervisor of Banks in recent years have helped to reduce this risk. With respect to the beginning of the second half of 2014, the interest rate was left unchanged for July and was reduced by 0.25 percentage points for August, to 0.5 percent.

 ·         Inflation and inflation expectations: The CPI was unchanged during the first half of 2014, and on a seasonally-adjusted basis declined by 0.2 percent. During the last 12 months, the CPI increased by only 0.5 percent, which is below the lower bound of the inflation target range (1.0 percent). The low rate of inflation derived primarily from tradable goods, the prices of which were affected by the continuing appreciation of the exchange rate and the low inflation abroad. Expectations of inflation for the coming year, from various sources, were relatively stable during most of the half year surveyed and were below the midpoint of the target range. Toward the end of the period, they moderated and moved toward the lower bound of the target range. The medium-term forward expectations (for two to five years) are at the center of the target range and the longer-term expectations are somewhat above the midpoint.

·         Domestic real economic activity: Growth during the surveyed period continued to be moderate. During the first quarter of the year, GDP grew by 2.9 percent while business sector product grew by only 1.8 percent (annual terms, seasonally adjusted). The slowdown during this period was reflected in the weakening of the components of domestic demand: consumption and gross capital formation. Exports in fact expanded during the first quarter at a respectable rate—following two years in which the rate of increase slowed—primarily due to the increase in services exports; however, there were indicators of a slowdown in exports during the second quarter. There were mixed indicators in the labor market: unemployment was low and the participation rate was high, but other indicators pointed to weakness, such as the real wage, the number of employee posts in the business sector and the number of job vacancies in the business sector.
·         The global environment: The slow recovery in growth continued in advanced economies while in developing countries the rates of growth are slowing, though they remain higher. Monetary policy remained highly accommodative worldwide. The US Federal Reserve continued its quantitative easing program but began tapering its scope, and the federal funds rate remained close to zero. The European Central Bank (ECB) reduced its interest rate towards the end of the period, which included the lowering the interest rate on excess reserves of the commercial banks to a negative level, and announced its intention to inject liquidity through asset purchases.
·         The exchange rate: During the surveyed period, the shekel appreciated by 1.9 percent in terms of the nominal effective exchange rate, by 1.5 percent relative to the dollar and by 2.2 percent relative to the euro (the average in June 2014 relative to the average in December 2013). The rate of appreciation of the shekel thus moderated relative to 2013. The real exchange rate was relatively stable during the period and appreciated by 0.2 percent. The relative stability of the exchange rate was partially the result of the foreign exchange purchases by the Bank of Israel.
·         The housing market: Home prices continued to increase. During the 12 months ending in May, home prices rose by 8.8 percent. Since the end of 2012, they have increased by an annual rate of between 7 and 10 percent. At the same time, there was a significant decline in the number housing transactions during the first half of the year, in part due to the expected implementation of the government's plan to reduce VAT to zero for eligible home buyers and to encourage building at target prices.
·         The financial markets: Stock market indices rose during the surveyed period at similar rates to those in other advanced economies. There was a decline in the economy's risk level, as measured by the CDS premium on five-year external debt. During the surveyed period, the downward trend continued in real and nominal long-term yields. In the credit market, there was a contraction of credit to the nonfinancial business sector, with a narrowing of corporate bonds yield spreads. The total outstanding credit to households, led by housing credit, continued to grow at a rate that was characteristic of the last two years. However, the risk characteristics of new mortgages moderated.
·         Fiscal policy: The deficit in domestic government activity (excluding net credit) totaled NIS 2.3 billion during the first half of the year and expectations during the surveyed period were that the government would not exceed the deficit ceiling set for 2014 (i.e., 3.0 percent of GDP). The deficit during the first half of the year was lower than the seasonal path consistent with meeting the deficit ceiling. This is because the level of expenditure was lower than the path consistent with full performance of the budget.
·         The forecast: According to the forecast published by the Research Department at the end of June this year, inflation during the next four quarters is expected to be 1.6 percent, which is in the lower part of the target range, and is expected to be only 0.4 percent for 2014. The low forecast is the result of the following factors: a lack of indicators pointing to inflationary pressure from domestic demand, continued moderation in the rate of increase in the housing component (rent) of the CPI, the effect of the appreciation of the shekel and low inflation environment worldwide against the background of surplus production capacity. GDP is expected to grow by 2.9 percent in 2014. Accordingly, the Research Department expects that the interest rate will stand at 0.75 percent in the last quarter of 2014. These forecasts are lower than those that were available to the Monetary Committee during the surveyed period.




Monetary Policy Report 2014 - First Half -PDF File