Monetary Policy Report 2012, Second Half
Monetary Policy Report 2012, Second Half
- Monetary and macroprudential policy: In the second half of 2012, the Bank of Israel reduced the interest rate by 0.75 percentage points, to 1.75 percent for January 2013. This was in order to strengthen the economy's ability to deal with the possible negative consequences of a worsening slowdown in the global economy. This step was taken in light of the absence of inflationary pressures, and the increasing signs of a moderation in domestic activity during the second half of the year, particularly toward its end. During this period, monetary policy was accompanied by uncertainty regarding global developments, the GDP growth rate, fiscal policy, changes in markets' reaction to the security and political conditions in the region, and developments in the housing market. In November, against the background of the increase in transactions, and the increase in prices in the housing market, and the marked increase in the balance of housing credit, the Supervisor of Banks issued a directive limiting the loan-to-value ratio of housing loans. The interest rate for February 2013 was kept unchanged at 1.75 percent.
- Inflation and inflation expectations: In the second half of the year, the inflation environment ranged slightly below the midpoint of the target range. In the half year reviewed, the CPI increased by 0.7 percent, and increased by 1.0 percent on a seasonally adjusted basis. For the full year of 2012, the CPI increased by 1.6 percent. In the second half of the year, prices of, inter alia, energy, communications, and education declined, and the rate of increase of rents moderated. In contrast, there was a 3.6 percent increase in the food component. Against the background of shekel depreciation, the VAT increase, and other tax increases expected in the beginning of 2013, 1-year inflation expectations increased in the middle of the half reviewed to about 2.5 percent. However, toward the end of the year they declined and were slightly below the midpoint of the inflation target range (1–3 percent per year). Inflation expectations for the medium and long terms were stable during the half, at around 2.2–2.5 percent, indicating credibility of monetary policy.
- Domestic real economic activity: The economy's rate of growth during the year was around 3 percent (in annualized terms). However, after uses expanded at a relatively rapid pace in the first quarter, there was a moderation—and even a decline—in some of them during the second and third quarters, as an effect of the global slowdown. The unemployment rate and real wages were stable during the year, and the participation rate increased. Various surveys indicated an expected moderation in activity and a slowdown in recruiting workers.
- The global economic environment: The slowdown in activity in Europe continued in the third quarter of 2012, and it began to affect the core countries of the eurozone as well. In the fourth quarter, there was some improvement in the markets, following accommodative policy measures and declarations of the intent to keep the eurozone intact. These were reflected in the assessment that the probability of a deterioration in the crisis, and the breakup of the eurozone, declined. In the US, the improvement in real activity continued, though there was increased uncertainty regarding the budget deficit, in particular the handling of the "fiscal cliff", for which a partial solution was found only on the last day of the year. In Japan, the slowdown deepened in the third quarter, after a near standstill in activity in the second quarter. In major emerging and developing markets, there was a slowdown in the growth rate during most of the reviewed period, and at the end there was a slight recovery. Worldwide, the expansionary policy continued: in addition to interest rate reductions, quantitative easing programs were extended and added.
- The exchange rate: The shekel weakened in terms of the nominal effective exchange rate in the third quarter, and it appreciated during the fourth quarter. At year end the exchange rate was at a level similar to that in the beginning of the year. In the beginning of the third quarter the shekel depreciated, against the background of concerns of a debt crisis breaking out in Europe. This concern dissipated after Europeans displayed commitment to maintaining the euro bloc and to dealing with the debt problem. Nonetheless, the shekel remained depreciated, due to, among other things, an increase in local geopolitical risks. In the fourth quarter, security concerns diminished, and the shekel appreciated.
- The financial markets: The trend of decline in the risk premium measured in domestic financial markets, which began in the first half of the year, continued in the half year reviewed. Domestic stock prices increased, moving in tandem with returns on leading financial markets, and even surpassing some of them. Yields to maturity of government bonds, which currently are fairly low, increased in August–September, similar to the worldwide trend. However, they later declined, in contrast to the worldwide trend. Risks reflected in CDS contracts and in the VIX increased in the third quarter and declined in the fourth quarter. The balance of credit to the business sector, primarily bank credit, remained stable, with growth in non-bank credit along with a decline in credit from abroad. In contrast, the balance of credit to households increased. The increase occurred almost completely in housing credit.
- Fiscal policy: In the beginning of the second half of 2012, there was uncertainty regarding the steps that would be taken in order to reduce the deficit in 2012, regarding the approval of the 2013 budget, and regarding the deficit and government expenditure in 2013. Later in the half, the increases in tax rates—some of which went into effect in 2012—reduced the concern of eroding credibility of fiscal policy. The deficit in 2012 was 4.2 percent of GDP, compared with an estimate of 3.4 percent of GDP at the beginning of the year, and an original target of 2 percent of GDP which was set at the end of 2010. The deviation in the deficit stemmed mainly from tax receipts which were lower than forecast when the budget was being constructed.
- Home prices: After home prices remained stable in the first quarter of the year, they increased by a cumulative 5.4 percent from March-April to October-November. In the third quarter, along with the increase in home prices, there were marked increases in the volume of new mortgages and in the number of home purchases. Together, these increased the concern of a renewed trend of increase in home prices, especially in light of a decline in the Israel Land Administration's rate of marketing properties.
- The forecast: Based on the staff forecast which was published at the end of December 2012 (an updated forecast is expected to be published at the end of March 2013), the Research Department projects that the rate of inflation during the next four quarters will reach 1.8 percent. The growth rate in 2013, net of the effect of expected gas production from the Tamar reservoir, was revised slightly downward to 2.8 percent. The downward revision in projected growth reflects the worsening in global activity, a deterioration which is expected to continue. Likewise, it reflects a continuing negative effect of Operation "Pillar of Defense" on incoming tourism. The growth forecast including natural gas production, which is not expected to impact on the level of employment or unemployment in the short term, is 3.8 percent. The Bank of Israel interest rate is projected, according to the forecast, to be 1.75 percent through all of 2013. The main risks to the forecast are a deterioration in the debt crisis in Europe, geopolitical and regional political risks, uncertainty regarding fiscal policy after the elections, and the risk—which recently declined—from fiscal restraint in the US.
 The Central Bureau of Statistics survey of owned homes presents home prices on a two-month basis.
 The last forecast during the period being reviewed was presented on December 24th, 2012, the date of the publishing of the interest rate decision for January 2013. The forecasts that were presented to the Committee during the period being surveyed will be discussed below.