Hello all.
As you know, the Monetary Committee today decided to continue its accommodative monetary policy, and to leave the interest rate at 0.1 percent.  We have again seen an illustration that the environment in which policy operates both in Israel and around the world does not cease to surprise or to provide dramatic developments that pose complex challenges and dilemmas to policy makers.
In departure from my custom, I would like to relate at the outset to events of the past few days.  Despite the fact that various polls were quite close, the results of the referendum in the UK surprised the players in the financial markets, and were reflected in sharp movements in the exchange rates, the stock and bond markets, and other financial indicators.  There have been only two trading days since the results were made known.  Volatility remains high, and it is still difficult to know what the final short-term effects of the referendum will be on the financial markets.  The Bank of Israel and the Ministry of Finance have been keeping close watch on developments in the financial markets since Friday morning, and on their possible effects on the Israeli financial system, and are in constant contact with the institutions under our supervision and with colleagues around the world.  It is clear that lower rates on the most important financial markets around the world have an effect on the assets of Israeli investors.  However, it is precisely for periods such as this that we must maintain the stability of the financial system over time, and particularly the robustness of the banking system, by ensuring proper capital and liquidity levels among other things.  The strength of the Israeli economy is also reflected in the macroeconomic variables, such as low public debt levels, high foreign currency reserve levels, a Current Account surplus, and a robust labor market.
According to assessments by the various international institutions, assuming that the event does not develop to the point of further negatively impacting the structure of the European Union, Britain’s departure from the European Union is not expected to have a dramatic effect on global growth, despite the fact that it may have a significant impact on the UK itself.  For instance, the International Monetary Fund just recently conducted various scenarios for such a possibility, and estimated that the volume of damage to global GDP that will accumulate within a few years is between 0.1 and 0.3 percent.  The uncertainty that has been generated, inter alia, by the fact that it is unclear how the new arrangements between the UK and its trading partners will look, or to what extent the UK’s decision will strengthen the trends in other countries that are negatively impacting the global economy in general and international trade in particular.  We can hope that the various arrangements that will be formulated, including between the UK and Israel, will prevent a negative impact to trade beyond what may take place as a result of the weakening of the pound sterling (should that persist).  Britain is a significant trading partner for the Israeli economy, and it is important to maintain the economic ties between our two countries.
I will now move to a review of the economic events in view of which monetary policy has operated during the past quarter, and how those events are perceived by the Monetary Committee, which continues to assess that monetary policy will remain accommodative for a considerable time.
The CPI began increasing again in April–May, but the inflation environment remained very low during the second quarter.  The increase in global fuel prices continued, and in the past month, they have stabilized around $50 per barrel.  The effect of administrative price declines on the CPI has also wound down for now.  Additional factors such as the rapid increase in wages, the increase in private consumption, and low interest rate, and stability of the exchange rate will contribute to the convergence of inflation to within the target range, although this is still expected to take place—according to updated assessments—only in another year.  It is important to note that in prevailing assessment in the markets remains that monetary policy will achieve the inflation target over time, as reflected by long-term expectations that are anchored around the center of the target range.
Despite our assessment that there was a moderation of economic activity in the first quarter, National Accounts data for the first quarter were surprising to the downside, even after the improvement shown in the second estimate of those data.  The decline in exports reflects, apparently in part, unique developments—some of which are temporary—in a number of industries that comprise a high proportion of Israeli exports, and does not have an immediate effect on employment.  However, it took place following a number of years of standstill in exports, and we cannot ignore the difficulties in which the export sector finds itself in view of the relatively low growth of world trade and the accumulated effective appreciation.  In contrast, private consumption continues to grow strongly, supported by the low interest rate and the continued increase in wages.  The indicators that have so far become available make it possible for us to cautiously assess that in the second quarter, the economy returned to the growth rate that has characterized it in recent years, although there was no compensation for the low growth of the first quarter.  The labor market continues to show positive data of a decline in unemployment, an increase in the number of job vacancies, an increases in employment—mainly in the commerce and services industries—and an increase in wages.  There is a decline in the rate of those employed part-time, such that the economy is nearing full employment, and it is possible to sense significant difficulties in obtaining workers in a number of industries.  Over time, it is important that economic policy operate to maintain and strengthen the Israeli economy’s relative advantage and to increase labor productivity, in order for it to be possible to ensure high earning power and an increase in the standard of living.  Monetary policy can, at most, buy time to enable the required long-term changes in structured policy.
Even before the results of the British referendum were known, and to a certain extent as a result of the uncertainty surrounding what those results would be, the moderation in the global economy to which we have been witness for some time continued, with an emphasis on the emerging markets, and a continued decline in the growth rate of world trade.  As in Israel, growth in a large number of countries derives mainly from the services sector, while manufacturing has been in a standstill.  The international institutions continue to assess that risks to growth tend downward.  We will need to monitor the extent to which the short-term forecasts are revised as a result of the results in the UK.  Following accommodative measures in the previous quarter, no significant measures were taken in the past three months by the major central banks, but assessments regarding the next interest rate increase by the Federal Reserve were again delayed.  In the context of developments in the UK, some of the central banks declared their readiness to provide sources to the banking system and to open foreign currency liquidity lines between the central banks.  In Israel, the need for such measures is not foreseen, since the level of liquidity in the Israeli banks is adequate. The Bank of Israel will continue to examine the effect of global monetary policy over time on the Israeli economy and on the necessary policy in Israel.
In the last quarter, and looking longer-term as well, the trend of appreciation in the effective exchange rate has been halted, although there are obviously short-term fluctuations that, in the last quarter, added up to a slight depreciation.  This means that the exchange rate has stabilized at a level that, according to various models, is over-appreciated relative to the equilibrium exchange rate, which is reflected in the developments we are seeing in exports and in manufacturing over time.  The Current Account surplus enjoyed by the Israeli economy is contributing to appreciation of the shekel.  However, the increase in the surplus has recently been mainly a result of the decline in energy prices, from which most of Israel’s trading partners have also benefitted, and it should therefore not cause appreciation vis-à-vis those countries.  It is important to remember that most of the central banks around the world are adopting very accommodative monetary policies that are acting, inter alia, to weaken their currencies, and these measures are creating distortions in the global exchange rate system.  This situation may lead to an erosion of profitability among many businesses in Israel to an extent that will not allow them to survive this period.  In contrast, when the foreign exchange markets return to equilibrium, it is likely that these businesses will not reopen.  Against this background, the Bank of Israel’s intervention in the foreign exchange market, which has prevented further appreciation, is an integral part of monetary policy.  In view of the level of the interest rate and the possible ramifications of a further reduction—mainly on the housing market—the Monetary Committee is of the opinion that policy in the foreign exchange market is the proper tool to support a return of inflation to the target range, as well as to support exports, manufacturing, and employment at this time.
During the last quarter, the rapid increase of home prices continued.  The government is making significant efforts to increase supply, and we have seen a high level of building starts, a high stock of unsold homes, and a continued increase in the number of building permits, despite the fact that there has recently been some moderation in building starts and a lengthening of construction duration.  The banking system’s recognition of the fact that the risk derived from housing credit is increasing, partly as a result of the cumulative effect of regulatory actions taken by the Banking Supervision Department in recent years, has led to some increase in mortgage interest rates, after those rates decline in recent years to very low levels.  The efforts to increase supply and the increase in mortgage interest rates, which will lead to some cooling of demand, will contribute to stability in the housing market.
Today, the Research Department published its revised forecast which, as mentioned, is a conditional forecast based on assumptions regarding exogenous variables.  In order to assess the effect of the UK leaving the European Union, the Research Department relied on assessments by the International Monetary Fund regarding the implications of the Brexit on global economic activity, which were published just prior to the referendum. Even so, this time, the uncertainty inherent in the forecast is particularly high since, as stated, it is still difficult to derive conclusions from the event. According to the forecast, growth in 2016 will total 2.4 percent, compared with 2.8 percent in the previous forecast.  The decline in the forecast is a result of the low growth in the first quarter, and does not indicate further moderation in the future.  The forecast for 2017 declined by only 0.1 percent. The projected path of inflation is similar to that in the previous forecast, but is expected to return to within the target range in the second half of 2017.  The interest rate path is also low.
In conclusion, monetary policy operated during the second quarter as well against the background of low inflation, an appreciated exchange rate, continued very accommodative monetary policy by the major central banks, and moderation, apparently of a continuing nature, of economic activity in Israel.  To all of that, a high level of volatility and uncertainty has been added in recent days in view of the news from Britain.  An analysis of the sum total of these developments leads the Monetary Committee to continue its assessment that monetary policy in Israel will remain accommodative for a considerable time, with the use of foreign exchange purchases, as necessary, in order to moderate the effects of moderation in world trade and the fluctuations in global exchange rates on economic activity and inflation in Israel.
The Committee’s position that the strength of the labor market and the risks inherent in the housing market do not currently justify the use of additional tools is valid today.  With that, various tools remain at the disposal of the Monetary Committee.  The Bank of Israel is monitoring developments in the domestic and global economies on a daily basis, and will not hesitate to use all the tools at its disposal should the circumstances make it necessary to do so.