Remarks by the Governor of the Bank of Israel at the press briefing on monetary policy held today at the Bank of Israel
Yesterday and today, the Monetary Committee held discussions at the Bank of Israel in order to decide on the interest rate. At their conclusion, as we announced, the Committee decided to keep the interest rate unchanged at 0.25 percent. The discussions are never simple, and this time they were particularly complex, as in recent weeks there have been significant developments, not all in the same direction, in some of the parameters on the basis of which the Monetary Committee formulates the policy. The inflation environment went up further, if only moderately. Real activity continues to be robust, and in particular, the labor market remains tight. The uncertainty increased with the decision to hold elections again, and at this stage, it is particularly difficult to assess what steps the government will take to deal with the problem of the deficit and what their effects on the economy will be. In the global economy, a picture of a slowdown and a decline in inflation is developing, against the background of intensifying political risks, which are leading to the increased probability of a turnaround in monetary policy at some of the major central banks. After examining these and other developments, the Committee continues to assess that in the baseline scenario, the rising path of the interest rate in the future will be gradual and cautious, in a manner that supports a process at the end of which inflation will stabilize around the midpoint of the target range, and will continue to support economic activity. I will refer now to developments in the various areas and to the policy ramifications.
Inflation continues to increase moderately, driven by nontradable goods prices, which serve as an approximation of domestic inflation, while inflation in tradable goods prices is still low. In recent months, inflation has been relatively high—most of the recent CPI readings were slightly higher than expected, and in May, the 1-year inflation rate reached 1.5 percent, for the first time since 2013. Although in the coming months some moderation in the year-on-year inflation rate is expected, the probability of inflation returning to below the lower bound of the target currently appears lower. The increase in inflation has relied partly on factors that will not necessarily persist, such as the increase in the CPI’s fruit and vegetables component and the energy components’ contribution to inflation returning to being positive. However, the expectations and forecasts from most sources indicate that in the coming year inflation will continue to hover slightly above the lower bound of the target range, and after that it is expected to increase toward the midpoint of the target. As I noted, there is uncertainty regarding the government’s post-elections policy, and its potential impact on prices, but the economy’s being at full employment, the tight labor market and the increases in wages are the main fundamental factors expected to support the continued increase in inflation. Since a main risk to the continued increase in inflation toward the midpoint of the target range is the possibility that the appreciation in the shekel exchange rate will continue, a gradual and cautious path of increasing the interest rate is prudent, and consistent with a continued moderate increase of inflation toward the midpoint of the target range.
Real activity continues to expand at a solid pace. However, some indicators of current activity were slightly weak: the Composite State of the Economy Index increased in May by a lower rate than previous months, the Companies Survey indicates weakness in the second quarter, and the Purchasing Managers Index and Consumer Confidence Index were low; however, the Business Tendency Survey conveys a positive picture, and overall we assess that the economy continues to grow in line with its potential rate, despite the slowdown in the global economy. As I noted here at our previous meeting, the volatility in vehicle imports does introduce some noise into the data, and led to first quarter growth being relatively high, and the official second quarter growth figure is expected to be low. However, net of this effect, it appears that second quarter growth did not decline. The increase in wages and the growth of the labor input have supported growth of private consumption over recent years. The moderation of consumption in recent quarters appears consistent with the exhaustion of the process of expansion in the labor market in its ability to contribute to growth. The labor market is characterized by a very low level of unemployment, high levels of employment and participation, and wage increases; the job vacancy rate has declined in recent months but its level remains high. In view of the slowdown in world trade and the cumulative appreciation in the shekel, some weakness is apparent in goods exports, while services exports continue to grow at a solid pace. The budget deficit widened in recent months, and as the Bank of Israel has noted, the government will have to take adjusting steps of some sort immediately when it becomes possible after the elections. As long as the fiscal contraction is carried out in a manner where growth is limited by supply and not by demand, its effect on activity will apparently be moderate. I emphasize that the uncertainty regarding the budget is liable on its own to impact growth adversely, and all elected officials must work toward the uncertainty ending as soon as possible.
In recent months, developments in the global economy have been the main source of worry for us. Over several months, we have seen weakness in the economies of Europe and in emerging markets, and recently there have been some signs of a possibility of some slowdown in the US. The growth in world trade halted, and the “trade war” is the main factor weighing on sentiment of real activity and on financial markets. Although at the G20 summit a further deterioration was avoided, the growth forecast for most regions was again revised downward, and there are additional political and geopolitical risks in the world. Inflation is weakening, and deviating further away from the targets guiding the central banks. These developments led to the current expectation of a turnaround in monetary policy worldwide. The Federal Reserve is signaling the possibility of an interest rate reduction as early as at its next meeting, even if expectations for a sharp decline were moderated against the background of the positive data in recent days, and the ECB as well has not ruled out the possibility of further intensification of the very accommodative policy it has adopted for several years. The small and open economies are impacted by developments in the large blocs; in some of them, central banks have already responded with accommodative monetary steps, and others have signaled such steps in the future. However, policy makers respond first and foremost to domestic developments.
In the past year, the shekel has strengthened by 4.3 percent in terms of the effective exchange rate, but in recent weeks, the exchange rate has been relatively stable. The possibility of global monetary policy changing direction could impact on the exchange rate. In any case, to the extent that there is renewed appreciation, it will hold back the inflation rate’s rise toward the midpoint of the target, and thus could impact on the Bank of Israel’s monetary policy path. Should there be anomalous fluctuations that are not in line with fundamental economic conditions, the foreign exchange market intervention tool remains available to the Bank of Israel.
The Research Department’s updated macroeconomic forecast is very similar to the one the Department presented 3 months ago. The Department assesses that in 2019, GDP will grow by 3.1 percent, compared with 3.2 percent in the previous forecast, and in 2020, growth of 3.5 percent is expected. In both 2019 and in 2020, the inflation rate is expected to be 1.6 percent. Regarding the interest rate path in the forecast, I emphasize that it is not a forecast by the Monetary Committee itself, but by the Department’s economists, who assess that the interest rate will be increased at the end of the third quarter of 2019. However, this assessment is based on a large number of parameters regarding which uncertainty is particularly high at this time, and that could change by the next interest rate decision, such as downward surprises in data to be published regarding inflation and growth in Israel, a decline in assessments of future inflation, the risk of a further deterioration in the global economy, changes in monetary policy by major central banks, and the possibility of shekel appreciation—all of these, if they materialize, could lead to an increase in the interest rate occurring at a later date than that in the Research Department’s forecast.
The Monetary Committee reaches its decisions while attempting to assess what steps are required in the present in order to achieve the policy targets in the future. Forecasting the future is always a complex job, but at this time there is a feeling that some of the developments we are seeing have an especially high level of uncertainty, and therefore it is more difficult to assess their outcome. The political uncertainty in Israel continues, and the news from the global economy changes all the time, changing the assessments regarding activity, inflation, and monetary policy worldwide. At this time, in view of the slight increase that I mentioned in the inflation environment, the robustness of the labor market in particular and of economic activity in general, and the stability in the exchange rate, it could be that in the framework of the gradual and cautious path toward which the Committee is pointed, it will be necessary to raise the interest rate in one of the upcoming decisions. Nonetheless, in light of the uncertainty regarding the data that will become available in the coming weeks, and particularly regarding global developments, the Committee emphasizes that it will be possible to continue accommodative monetary policy for a longer time, in a manner consistent with achieving the targets of the policy.