Remarks by the Governor of the Bank of Israel at the press briefing on monetary policy held today at the Bank of Israel

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Good afternoon.

Yesterday and today, the Monetary Committee held discussions at the Bank of Israel in order to decide on monetary policy.

The Monetary Committee analyzed the overall impact of the various processes affecting economic activity and inflation, and at the end of the discussions decided to leave the interest rate unchanged.

In my remarks today, I would like to discuss the main considerations that we took into account when making the decision, as well as the economic environment. I will comment on the path of monetary policy and refer to the main developments in the inflation environment, the assessments regarding future economic activity, the development of the exchange rate, global economic conditions, and other relevant issues at hand.

Since the second half of 2021, we have been in a process of tightening monetary policy, against the background of the major economic developments in the domestic and international environment. These led us in Israel, as with other central banks worldwide, to adopt a determined process of interest rate increases, which we began in April 2022.

The Monetary Committee decided not to increase the interest rate, as in view of the existing data, and the current forecasts, we assess that the current interest rate level is sufficiently restrictive to support the decline of inflation to its target. However, the road to inflation’s convergence to its target is still long. We are in an environment of great uncertainty, and there are several upside risks to inflation pressures. Therefore, it is important to me to note that it is certainly possible that we will need to increase the interest rate going forward, if we see evidence that the inflation environment is not moderating at a suitable pace. We are determined to return inflation to its target and to ensure price stability in Israel.

Later in my remarks, I will go into further detail about the state of the economy. At this point, I will note that the decision was made against the background of the data on economic activity in Israel, which point to a high level of activity. We see growth above expectations, and a tight labor market with participation rates at record levels and a very low level of unemployment. However, several indicators point to some slowing—the job vacancy rate is contracting, mortgage volume has decreased in recent months, and the scope of credit to small and midsized businesses stabilized. All these point to the beginning of a trend of moderation in the economy, deriving from the interest rate policy, which is working to reduce inflation.

Inflation in Israel is still at an elevated level and encompasses a wide range of CPI components. However, in recent months, some moderation in inflation can be seen, as indicated by inflation momentum measured over shorter periods, such as when measuring inflation over the last three and six months (on an annualized basis). The inflation data to be published over the coming months, will help clarify the picture regarding the inflation dynamic and the policy path along which we need to move. Of course, the Committee examines the range of economic developments in Israel and abroad all the time. I will again emphasize, price stability is a necessary condition for economy stability. A stable price environment creates certainty—and that is an essential component for economic activity and growth. More than that, it is important to understand that high inflation adversely impacts weaker population groups first and foremost. Therefore, the Bank of Israel is determined and committed to returning the inflation rate to its target.

Looking forward, various entities in the economy, such as the capital market or economic forecasters, expect that inflation will return to its target over the next year. Market expectations for longer terms are also within the target range. These provide us with important information on how market participants see the economic situation and their viewpoint on the monetary policy’s impact on inflation. It is important to remember that these expectations are part of the equilibrium and are determined, among other things, in light of the interest rate policy we have adopted, and the credibility that the markets ascribe to the Bank of Israel’s monetary policy.

I noted before that we are of the opinion that monetary policy is sufficiently tight for the continued moderation of inflation. This is true so long as there will not be marked changes in activity and in the inflation environment. In this regard, I will note that in the past half year, we have experienced a marked depreciation of the shekel, depreciation derived mainly from domestic factors and less from the global environment. Based on assessments, during this period there was an “excess depreciation” of the shekel, which does not derive from the economic factors that characterized the foreign exchange market in recent years. Conservative assessments indicate that this “excess depreciation” has contributed so far about 1–1.5 percent to inflation. To the extent that the shekel’s weakness will continue, it is liable to weigh on the return of inflation to its target, and therefore necessitate a more restrictive monetary policy.

Let me now refer to the state of real activity, as we in the Monetary Committee see it.

The Israeli economy is robust and growing at a faster pace than had been expected, due to the investment component and to services exports. Economic activity continues to be strong and the labor market is tight. However, we see several economic data indicating some moderation in the pace of activity. The job vacancy rate has been declining (particularly in the high tech sector), credit card expenditures are moderating, real estate market activity is slowing, business credit volume to small and midsized businesses is stabilizing, and there is a sharp decline in funds raised by high tech companies.

Today, the Research Department published an updated macroeconomic forecast. The forecast is based on a scenario in which the disagreements around the changes in legislation is resolved in a manner that does not impact on economic activity going forward. In this forecast, the Department's assessment is that GDP will grow by 3 percent a year in both 2023 and 2024. This rate is somewhat lower than the economy’s long-term potential rate. Based on the forecast, the unemployment rate is expected to increase to around 4 percent. Year over year inflation is expected to decline to 3 percent, on average, in the second quarter of 2024 and to 2.4 percent at the end of 2024. There are several significant sources of uncertainty to its forecast outlined by the Research Department. The main risk to the forecast is the realization of a scenario in which legislative and institutional changes are accompanied by an increase in the country's risk premium and continued depreciation of the shekel, an adverse impact on exports, and declines in domestic investments and demand for private consumption. In the previous forecast, in April, we published a quantitative assessment of the economic ramifications of such a scenario.

We are closely following housing market developments, and see that activity in this market continues to moderate. The Home Prices Index declined slightly in May, further to the marked trend of moderation seen in recent months. The volume of transactions in the market, mortgage volume, and data on building starts are on a downward trend. In this regard, I will note what I have said in the past: it is important that the government knows how to ensure a high supply of construction over time. This is the key to the continued moderation of housing prices, and we shouldn’t rely in this regard solely on the increase in interest rates to moderate home prices.

In the domestic capital market, equity indices in Israel continue to be characterized by underperformance compared to major equity indices worldwide. Long-term government bond yields ended unchanged relative to their level at the previous interest rate decision, similar to the global trend. In the credit market, corporate bond spreads in Israel that expanded in the beginning of the year, remained unchanged and the scope of credit to small and midsized businesses is stabilizing. However, the reported difficulty in attaining funding reported by companies of various sizes remains at a relatively low level.

With regard to global activity, modest growth is forecasted in the major blocs in 2023 and 2024. At the same time, the eurozone entered a technical recession over the previous two quarters, in which the there was contraction in the GDP. The inflation environment worldwide is moderating, but core inflation continues to be sticky, and the monetary tightening worldwide continues.

I would like now to speak a bit about the banking system and the recent steps taken by the banks. As has been published, about two weeks ago I invited the CEOs of the commercial banks to a meeting. At this meeting, I clarified that the banking system should act to achieve several goals: reducing interest rates on overdrafts; increasing the interest rate passthrough on positive balances in current accounts and on deposits along the entire curve; active and continued encouragement to shift excess money held in a current account to deposits and to other channels that are better remunerated, and active assistance for mortgage holders identified as having the most significant difficulties. The steps taken by the banks since the meeting are moving in the right direction and can benefit the relevant customers. The processes we are promoting and will continue to promote in the future are those that encourage the activity of market mechanisms and business competition with variance in the value offered between the various entities, both in the banking system and outside of it. In contrast, legislative intervention in market mechanisms, certainly steps that are liable to distort monetary policy, are ultimately liable to achieve an undesired outcome. We will continue to act with the tools available to us to achieve these goals to improve customer experience and to promote competition in the financial system.

In conclusion, I would like to say a few words about judicial reform's impact on the economy, which has been on the public agenda over recent months. I have said several times in the past that due to the promotion of such reforms there was an increase in the level of uncertainty in Israel’s economy, reflected in, among other things, the excess depreciation of the shekel and the underperformance of Israel’s stock market. Continued uncertainty is liable to have notable economic costs, as reflected in the risks to the Research Department’s forecast, and some of which I noted earlier in my remarks. The IMF has also indicated, in its most recent report, the adverse impact from the continued uncertainty over time. Therefore, it is important to bring back the stability and certainty to the Israeli economy, and to verify that legislative changes will be carried out with broad agreement, and will maintain the strength and independence of the institutions.

Thank you.