Monetary Policy Report: First Half of 2021
Monetary policy: This report reviews the monetary policy during the first half of 2021 and the beginning of the second half of 2021. During the reviewed period, and after the exit from the third lockdown, the Israeli economy recovered at a rapid pace. This was against the background of the efficiency of the vaccinations, which led to a sharp decline in morbidity rates and made a broad easing of limitations on activity possible.
During the first half of 2021, the interest rate was kept unchanged at 0.1 percent. In addition, the Monetary Committee continued to operate some of the range of tools it announced during the course of 2020—government bond purchases, long-term monetary loans, and to a small degree, repurchase agreements (repos) with institutional investors. This policy was intended to provide macroeconomic support to exiting the economic crisis, to assist in the functioning of the credit market so that it would provide stable and low interest rates and an adequate supply of credit, and to support the attainment of the policy targets. This was in addition to ensuring the continued orderly functioning of the financial markets, enhancing the passthrough from the Bank of Israel interest rate to market interest rates, and encouraging demand and inflation.
As part of the monetary tools implemented by the Monetary Committee during the reviewed period, the Bank of Israel continued to purchase foreign exchange. In the middle of January, against the background of the rapid and outstanding appreciation of the shekel, the Committee announced a program in which it would purchase $30 billion in 2021. This was with the aim of supporting the attainment of the Bank of Israel’s targets and the recovery of the economy from the COVID-19 crisis, and particularly in order to support export industries and import substitute industries.
Domestic real activity: The data and indicators that were presented to the Monetary Committee in the half year reviewed showed the resilience of the economy after the 2 lockdowns that were imposed in 2020, and the rapid pace of recovery after the exit from the third lockdown and the broad easing of limitations on activity, with the fading of the coronavirus in Israel.
The labor market: Labor market data indicate that before the imposing of the third lockdown, the broad unemployment rate had stabilized at around 13 percent, and during the lockdown, it increased to 20 percent, a lower level than in the previous lockdowns. After the third lockdown, its rate declined gradually, reaching 9.8 percent in May. However, in March and April 2021, a sharp increase was seen in companies reporting a difficulty in hiring employees, alongside a marked increase in reports of job vacancies.
The inflation environment: During the first half of 2021, there was a gradual increase in the inflation environment. The year over year rate returned to positive values, after approximately a year of negative rates, and after the publication of the May 2021 CPI, the inflation rate returned to the target range. Year over year inflation through May 2021 was 1.5 percent. The annual inflation rate net of energy and fruit and vegetables was 1.0 percent. One-year inflation expectations from all sources increased during the half year, and beginning from April they were within the target range. There was also an increase in forward expectations for all ranges. These expectations for medium and long terms remained anchored within the target range.
The exchange rate: At the end of 2020 and the beginning of 2021, there was a sharp appreciation in the shekel due to the strengthening of foreign currency flows into the Israeli economy. On January 14, 2021, the Monetary Committee announced a change in the policy of the Bank’s activity in the foreign exchange market in 2021, with a declaration in advance of a program to purchase $30 billion during the year. From that date until the beginning of February, the shekel weakened by about 6 percent against the dollar, to a level of NIS 3.3/$. From then through the end of the reviewed period, the shekel remained stable both in terms of the nominal effective exchange rate and against the dollar and euro. This was while the Bank purchased approximately $25 billion since the beginning of the half year.
The global economy: During the half year reviewed, data on activity indicated the continued recovery of the global economy and of foreign trade in some countries, as a result of the increased pace of vaccinations and their efficiency. The improvement in activity also led to an upward revision in April of the IMF’s forecast. However, in some countries, morbidity levels remained high, and the broadening of the lockdowns, the limitations, and difficulties in vaccination campaigns moderated the pace of the exit from the crisis for those countries. The inflation rate increased in all the main blocs. Monetary policy in most countries remained very accommodative. Major equity indices in advanced economies reached record highs in the second quarter of 2021, though volatility was seen during the half year.
The credit market: Bank credit balances of large and medium-sized businesses increased over the course of the half year reviewed, and the pace of the change accelerated. In the small and micro business sector, credit balances increased moderately and their increase accelerated in May. The credit market continued to function with low and stable interest rates. Based on the Business Tendency Survey conducted by the Central Bureau of Statistics, the average level of difficulty in obtaining credit declined to levels seen before the crisis, except in the hotels industry.
Financial market developments: Since the beginning of the COVID-19 crisis, as well as during the half year reviewed, many central banks, including the Bank of Israel, continued to operate a variety of asset purchase programs. In Israel, the nominal government bond yield curve steepened slightly during the first quarter of the year, a process that continued in May and June as well. Corporate bond spreads continued to decline during the reviewed period, with their levels near those of just before the crisis. Prices have increased on Israel’s equity markets since the beginning of the half year. The Tel Aviv 125 Index increased by approximately 13 percent, surpassing its level of just before the crisis. During the half year, the Monetary Committee continued to follow equity market developments, with regard to maintaining financial stability.
Fiscal policy: Throughout the half year, Committee members expressed concern about the continued uncertainty deriving from the lack of a budget. The government deficit in the 12 months ending in May 2021 was NIS 149 billion, or about 10.5 percent of GDP. At the end of the year, it is expected to be around 7.1 percent of GDP.
The housing market: At the end of 2020 and in the beginning of 2021, an acceleration was seen in the rate of home price increases. In contrast, the pace of rent price increases remained moderate.
The Research Department’s staff forecast: The Research Department published three forecasts during the period being reviewed, in parallel with interest rate announcements—in January, April, and July 2021. Whereas during the crisis, at the time of uncertainty, the Research Department’s staff forecasts included 2 scenarios—one that assumed continued improvement in morbidity rates and a second that assumed a return to deterioration in morbidity rates—in the April 2021 forecast the Department returned to presenting a macroeconomic forecast based on a single baseline scenario, in light of the progress in the vaccination campaign and the decline in morbidity.
According to the forecast from July 2021, GDP will grow by 5.5 percent in 2021. The broad unemployment rate is expected to decline to 8.0 percent of the labor force at the end of 2021. In 2022, growth of 6.0 percent is expected, so that the level of GDP at the end of 2022 is expected to be only about 0.5 percent lower than the level that would have been expected before the crisis. The unemployment rate in 2022 is expected to reach 5.5 percent in the final quarter, still above its pre-crisis level. Assuming that the State budget is passed as planned and that fiscal consolidation will be deferred to 2023 and later, the debt to GDP ratio in those two years is expected to be 74 percent. Inflation during the course of the coming 4 quarters (ending in the second quarter of 2022) is expected to be 1.0 percent. The rates expected for 2021 and 2022 are 1.7 percent and 12 percent, respectively.
During the half year reviewed, the Committee discussed the economic risks to the forecast. Although the opening of the economy, the return to routine in Israel and the rapid recovery of economic activity are expected to support continued growth in the coming year, there are still challenges to activity. This is in view of the health risks in Israel and abroad—the risk of a renewed spread of the coronavirus, and particularly of the Delta variant in Israel toward the end of the half year, a situation that is liable to extend the closure of the economy to incoming and outgoing tourism. In addition to these, there are security risks, financial risks, and fiscal uncertainty. In addition, there is uncertainty regarding inflation abroad and its impact on inflation in Israel.
 The decisions in 2021 were made on January 4th, February 22nd, April 19th, May 31st, and July 5th.