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 monetary policy. Since our previous monetary policy decision, at the end of November, the country and the economy have been experiencing several contrasting processes. On the health front, the vaccine campaign for which we have been waiting began earlier than expected, and to date the vaccination pace is high by any measure. However, at the same time, morbidity is reemerging and is strengthening, there is growing concern about the possibility that a mutation that increases the rate of infection is spreading, and the government has decided on a third lockdown in order to reduce the scope of infection. On the political front, the Knesset dissolved without approving a budget for 2021 and the country is heading to its fourth election campaign in the past two years, with all that implies. The Monetary Committee tried to assess the overall impact of all these processes on economic activity and inflation, and in the end, decided to keep the interest rate at 0.1 percent, while the Bank of Israel continues to utilize a broad range of policy tools, as it has done throughout the crisis. Before I go into detail about the current picture presented to the Committee and the considerations that led to the decision, let me take this opportunity to summarize the events of the past year from the perspective of the monetary policy makers.
There is virtually no superlative that has not been used to describe the past year. It was exceptional in many aspects, and in the world of central banks as well, the year 2020 set more than a few records. If in January we were still dealing theoretically with the possible ramifications of a virus spreading in China, by February and March the rapid pace of developments forced us to take unprecedented policy steps, at broad scope, and at record speed. The collapse of financial markets with the imposing of restrictions on mobility and activity in many economies created an acute liquidity crisis in global markets. In Israel, this was reflected mainly in the bond and foreign exchange markets. In parallel with major central banks worldwide, the Bank of Israel acted rapidly to supply liquidity to the economy in shekels and in foreign currency, and succeeded in stabilizing the markets within a few days. We then turned to take a range of steps to ensure that the credit market was succeeding in supporting the needs of all borrower types in the economy—households, businesses, and the government. We did this through tools similar to those of other central banks—reducing the interest rate and purchasing government bonds, and later also corporate bonds—as well as via tools that we developed in accordance with the specifics of the Israeli economy. We identified early on the increased difficulty among small businesses, and we launched several programs to ensure that credit continued to flow toward those businesses as well. In parallel, while we have benefited from the banking system’s resilience and stability having been maintained over the years, we took, within the framework of the Banking Supervision Department’s authority, a broad range of steps to ensure the banks’ continued ability to extend credit to the economy. In addition, similar to what was done in other countries, we also led a voluntary framework for deferring credit payments at a scope of billions of shekels for households and small businesses adversely impacted by the crisis, which for them was a rapid response to the cash flow difficulty that was created.
The health crisis led to an economic crisis of unprecedented intensity, and required a determined response from government policy. Here, too, the fiscal credibility that Israel’s economy built up in the years prior to the crisis stood us in good stead. The political situation undoubtedly made things more difficult, and despite that, the government provided extensive assistance to the unemployed, to businesses that were adversely impacted, to the providing of the health system’s response, and more. The Bank of Israel continues to be involved in analyzing the economic challenge and in continuing to advise government ministries in all that is related to formulating the policy measures. The lack of an orderly government budget for 2021 and the need to rely on an interim budget, which was basically constructed in 2018, weigh considerably on the government’s ability to operate growth accelerators and to take steps to prepare the economy for the post-crisis period. However, it is important to find ways to efficiently use the budget designated for growth accelerators such as infrastructure, digitization and technology that are earmarked for 2021.
The economic developments over the course of the year repeatedly illustrated the resilience of the Israeli economy. The restrictions and the lockdowns led to a steep decline in economic activity, although each time the restrictions on supply were lifted, we saw economic activity rise sharply. Some businesses succeeded in aligning the features of their activity with the new situation, with the high-tech services industry notably well placed, as reflected in the continued growth of services exports, except of course for tourism exports. In the second lockdown, we already saw that the negative impact on activity was less severe than in the first lockdown. However, the labor market situation, even before entering the current lockdown, was far from encouraging. The unemployment rate did not succeed in going back down to single digits, and various indices show that the main adverse impact has been felt by employees in industries characterized by low productivity and wages. The negative impact has been concentrated in small businesses, particularly in industries whose characteristics do not allow the continued conduct of their activity under health related limitations. According to estimates, in 2020 there was a (net) decline in the number of businesses in the economy, for the first time in many years. As of now, we still do not have data on the effect of the third lockdown on the labor market and on businesses’ activity, and there is also uncertainty about the length of time that the limitations will have to continue to be in place.
The Bank of Israel Research Department published today an updated forecast in which it assesses that GDP will contract in 2020 by approximately 3.7 percent. There is considerable uncertainty around the forecast for the coming years, and the Department continues to publish a forecast based on two scenarios. Under the “rapid vaccination” scenario, the Department assumes that the by the end of the second quarter of 2021, the health situation will not require further significant limitations on economic activity. In this scenario, the economy is expected to grow by 6.3 percent in 2021 and by 5.8 percent in 2022. Even in this more optimistic scenario, GDP in 2022 is projected to be 2 percent lower than would have been expected without the crisis, and the broad unemployment rate at the end of the year is expected to be 5.4 percent. Under the more pessimistic scenario, in which the vaccination campaign is drawn out so that the limitations on economic activity last until the middle of 2022, growth of only 3.5 percent in 2021, and 6 percent in 2022, is expected, so that GDP in 2022 will be about 4.5 percent lower than its level expected without the crisis, and the broad unemployment rate will be 7 percent. In the first scenario, the increase in the inflation rate is expected to be more rapid than in the second scenario, but in both scenarios, the inflation rate remains below the target. In order to support the economic recovery and the return of the inflation rate to the target range, the assessment in the forecast is that the Bank of Israel interest rate will remain very low at 0–0.1 percent, and that the Bank of Israel will continue to enhance the extent of monetary policy accommodation as needed.
Throughout the crisis, we have been closely monitoring the developments in the credit market and its various derivatives. The data indicate, first and foremost, that credit in the economy continues to flow without an increase in interest rates, despite the marked increase in risk for some borrowers. The government-guaranteed credit funds are an important source of credit for many businesses, and the banking system’s framework for the deferral of loan payments, and later among credit card companies as well, enabled many households and businesses to reorganize their payment schedule and to avoid going into default despite the negative impact caused by the crisis. Recently, a new framework was formulated, with an emphasis on the need to renew repaying the credit, even if partially, so that the debt is sustainable for the lenders as well as the borrowers. We recently announced that in light of the anomalous circumstances of the crisis, the Bank of Israel will enable lenders from outside the banking system as well to receive credit at very convenient terms, provided the credit is used to provide inexpensive credit to small and micro businesses.
In addition, I am announcing today that after having finished the necessary legal and operational infrastructure, we began several days ago to implement the decision that enables the banks to pledge mortgage portfolios, too, as collateral against the loans that they receive from the Bank of Israel to extend credit to small and micro businesses. This tool, which until now had only existed primarily at the central banks of the US, Europe, and the UK, increases the banks’ incentive to provide credit to companies without eroding liquidity ratios, and can help in injecting credit rapidly into the economy in the future as well, to the extent the need for that arises. In parallel, the Bank of Israel continues to support a low level of interest rates for medium and long terms, and the ability for larger companies to raise funds on the capital market, through government bond and corporate bond purchasing programs that we announced in past months.
Inflation in Israel was low even before the crisis broke out, and the sharp decline in demand led to an additional step down in inflation, in Israel and abroad. The most recent inflation data are beginning to show a moderate increase, and if the recovery from the crisis will occur as expected, then inflation is expected to continue to increase. We assess that within several months, the year over year inflation rate will return to be positive, and after the expiration of the impact of the accumulated exchange rate appreciation—which I will discuss soon—it will continue to increase gradually toward the lower bound of the target range. It is important to note that throughout the crisis, the expectations for medium and long terms have remained anchored within the inflation target range.
Considerable uncertainly regarding the global economy continues. The marked increase in morbidity that preceded the vaccination campaigns has led to a return of restrictions and lockdowns in many countries, and particularly in major economies. However, some companies are succeeding in adjusting to the new conditions—the manufacturing sector continues to recover, and with it world trade, which is so important to a small open economy such as Israel’s. The political uncertainty around the world declined with the completion of the Brexit process and the clarification of the political picture in the US. Major central banks continue a very accommodative monetary policy, through maintaining the near zero interest rate level in the US and the negative one in Europe and Japan, and asset purchase plans and providing widespread credit. The accommodative monetary policy is expected to continue for several years at least.
After relative stability in the summer, the shekel began to strengthen at the beginning of October, and this trend accelerated in November and December. Part of the appreciation is a result of global developments—the dollar weakened against most currencies, and against the shekel as well, though the shekel appreciation vis-à-vis the dollar stands out compared to other currencies. Part of the appreciation can be attributed to good reasons: the Israeli economy benefits from a growing surplus in the current account. Leading technology companies continue to invest in the Israeli economy, and large investment institutions increased the scope of their holdings in Israeli government bonds, in view as well of Israel’s being added to the WGBI index. Services exports’ performance throughout the crisis have been notably good, and recently there has been a recovery in goods exports as well. However, it is difficult to assess the point at which the exchange rate is liable to be too strong for part of the export industries and import substitutes, and this is not a risk we would want to take during a crisis. Therefore, the Bank of Israel acted intensively in the foreign exchange market over the course of the year, purchasing a record $20 billion. This policy moderated the rate of the appreciation, in order to ensure that the shekel is not markedly appreciating more than what is in line with the dynamic window derived from fundamental forces. I reiterate and emphasize that this policy will continue in line with the need as assessed by the Monetary Committee, and that under current circumstances the level of foreign exchange reserves does not pose a limitation on the foreign exchange purchasing policy.
As I noted at the beginning of my remarks, the Monetary Committee decided today to keep the interest rate unchanged. In parallel, the Bank of Israel continues to utilize the entire arsenal of monetary tools that we have operated throughout the crisis—government and corporate bond purchases, special loan programs for increasing the supply of credit to small businesses, and intervention as needed in the foreign exchange market. In this way, the accommodative monetary policy will continue to accompany the Israeli economy’s exit from the economic crisis, and we are all of the hope that the light at the end of the health-crisis tunnel will grow bigger, so that 2021 will in fact be a year of recovery and growth, in all meanings.
Best wishes to everyone for a successful new year!