MONETARY POLICY REPORT July-December 2013
MONETARY POLICY REPORT for July-December 2013.
- Monetary and macroprudential policy: During the second half of 2013, the Monetary Committee reduced the interest rate for October by 0.25 percentage points, from 1.25 percent to 1 percent, after lowering the interest rate by a combined 0.75 percentage points during the first half of the year. In September, October and December, the Bank of Israel purchased foreign exchange in spot transactions as part of its policy of intervention in the foreign exchange market, in addition to foreign exchange purchases as part of the program the Bank declared in May that is intended to offset the surplus effects of the start of natural gas production on the exchange rate. In August, the Supervisor of Banks published restrictions on the provision of housing loans, which came into force in September (with full applicability in November), and which apply to the payment to income ratio, the portion of the loan that may be granted at variable interest rates, and the term to final repayment of the loan. These provisions reduce macroprudential risk and moderate the pass-through between demand for mortgages and the Bank of Israel interest rate, thereby allowing for much more flexibility in interest rate decisions.
- Inflation and inflation expectations: The Consumer Price Index increased during the reviewed period by 0.5 percent, and increased by 0.7 percent on a seasonally adjusted basis—a rate of increase that is slightly below the midpoint of the price stability target range. For most of the year, including the reviewed period, actual inflation (over the preceding 12 months) was slightly below the midpoint of the price stability target range. One-year inflation expectations from various sources declined during the reviewed period to about 1.6 percent.
- The housing market: Home prices continued to increase, and in the 12 months ending in October, prices increased by 8 percent, similar to the annual rate of increase (the rate of increase looking at the past 12 months) seen in each of the last ten months. Further, both the number of transactions and the volume of mortgages stabilized at high levels. In order to reduce the macroprudential risk derived from these developments, in August the Supervisor of Banks imposed additional restrictions on the provision of housing credit.
- Domestic real economic activity: The GDP growth rate remained moderate, similar to the past two years. The standstill in exports continued, mainly due to low levels of demand in the global market, but also due to the continued appreciation of the shekel in terms of the nominal effective exchange rate. In contrast, private consumption, public consumption, and the start of natural gas production supported continued growth. Even though growth remained moderate, the unemployment rate continued to decline, while employment in the public service sector increased.
- The global economic environment: During the reviewed period, global real economic activity remained moderate, and growth forecasts for 2014 continued to be revised downward. But at the end of the period, signs of some improvement were seen. Monetary policy worldwide remained highly accommodative. The European Central Bank lowered its interest rate in November by 0.25 percentage points. The US Federal Reserve announced tapering in the scope of bond purchases toward the end of December, while there were assessments at the beginning of the reviewed period that the tapering would begin as early as September. At the same time, the Fed repeated its commitment to maintain a low interest rate for an extended period. The decline in the default risk of European countries that had encountered financial difficulties continued. Emerging markets grew at a slower rate than had been characteristic in recent years, while China continues to lead growth, and growth forecasts were revised downward.
- The exchange rate: During the reviewed period, the shekel appreciated by about 2.5 percent in terms of the nominal effective exchange rate, and by about 4.5 percent against the dollar. The appreciation slowed during the second half of the year, inter alia following the Bank of Israel’s announcement of the foreign exchange purchasing program to moderate the effect on the exchange rate of natural gas production.
- The financial markets: During the reviewed period, the Tel Aviv 25 Index increased by about 11 percent, reaching historically high levels. The change in the stock index was for most of the period coordinated with the trend in advanced markets, other than in August and September, apparently as a result of the increase in geopolitical risk (assessments regarding a possible attack in Syria). Yields on government bonds increased in June—similar to yields worldwide, against the background of expectations of tapering in quantitative easing in the US—but toward the end of the year, they again declined. The balance of business sector credit remained stable. In contrast, the balance of household credit increased, with the increase taking place mostly in housing credit. Spreads in the corporate bond market continued to decline, and the balance of tradable bonds even declined slightly, due to net debt repayment and debt restructuring deals being formulated. Net funds raised was positive only in the real estate industry.
- Fiscal policy: At the beginning of the reviewed period, the government’s deficit target was raised as part of approving the budget, and during the reviewed period, the assessment was that the deficit that would be registered at the end of 2013 would be lower than the ceiling of 4.65 percent of GDP that was set when the budget was approved. Taking this into account, the government decided at the end of November to cancel plans to increase income taxes at the beginning of 2014, and in parallel to reduce planned expenditures for 2014 in the reserve and interest items. The gap between the deficit and the ceiling derived mainly from a reduction in the growth of expenditures, relative to their approved growth, and from one-time tax receipts.
- Staff forecast: According to the Staff Forecast that was published at the end of December, the Research Department projects that the rate of inflation over the next four quarters will be near the midpoint of the price stability target range. The Bank of Israel interest rate is expected to remain at its current level until the second half of 2014, and is expected to be 1.25 percent in the fourth quarter of 2014. GDP growth in 2013 is expected to be 3.5 percent (2.6 percent excluding the effect of natural gas production from the Tamar site). This projection growth rate is similar to the growth rate forecast in the previous Staff Forecast (from September). The forecast for GDP growth in 2014 and 2015, excluding the effect of natural gas production, was revised upward, with an upward revision of exports and of private consumption, as a result of improved assessments regarding global growth and the cancellation of the plan to increase income tax at the beginning of 2014.