Remarks by the Governor of the Bank of Israel at the press briefing on monetary policy held today at the Bank of Israel
As you know, the Monetary Committee decided today to keep the interest rate at 0.1 percent, and reiterated that it intends to maintain the accommodative policy as long as necessary in order to entrench the inflation environment within the target range. The Research Department published its updated macroeconomic staff forecast, and I will refer to it later on.
Since we met here at the previous press briefing, the inflation environment has been somewhat volatile, but remains below the target range. The picture of economic activity remains strong. The rate of appreciation in the nominal effective exchange rate moderated, with significant intervention by the Bank of Israel, but the exchange rate is appreciated. Moderate recovery continues in the global economy, but the extremely accommodative monetary policy still continues in Europe, Japan, and other economies. I will now expand on these developments and how they are expected to impact on policy.
In the past year, there was a moderate increase in the inflation rate, and in recent months it stabilized slightly below the target range. The higher inflation worldwide and domestic wage increases are contributing to the increase of inflation, but countering that, the shekel appreciation, the halt in the increase in energy prices, government measures to reduce the cost of living, and changes in consumer behavior and in competition in the economy are moderating the inflation rate. These are expected to lead to the annual inflation rate declining over the coming months, before returning to rise toward the target range. Despite the increase in recent months in short term expectations, they are still lower than the target, and are apparently impacted to a great extent by the appreciation in the exchange rate—thus it is likely that its impact on inflation has not yet been exhausted. Medium term and long term expectations fluctuated within the target range throughout the period, so market participants do not doubt the credibility of the inflation targeting regime, but are of the opinion that it will take time until the processes that I described are exhausted and annual inflation will return to the target range.
Economic activity continues to grow at a satisfactory rate. Net of the atypical effect of fluctuations in vehicle imports, the economy has been growing for the past year and a half by approximately 4 percent per year, and recent indicators enable us to assess that this growth will be reflected in second quarter data as well. After a long period in which private consumption drove growth, there are increasing signs that at this time there is a return to more balanced growth in the economy, with both exports and investments contributing. The effect of the appreciated exchange rate is seen mostly in goods exports, while services exports are growing at a solid pace. Over time, against the background of the appreciation, goods exports were weak compared with the increase in world trade, while services exports increased by a rate faster than that of global growth in services. The unemployment rate is very low—both from a historical perspective and in international comparison—and the slight increase seen in the most recent data is the result of an increase in the participation rate, and not from a shortage of workplaces. On the contrary—many industries are actually reporting a shortage of workers, as evidenced by the high level of job vacancies.
In the past half year, home prices stabilized, and a range of housing market data indicate that the market is cooling off: the decline in the number of transactions continues, and the monthly pace of new mortgages taken out moderated, even though the increase in mortgage interest rates was halted. Government efforts to continue to increase the supply of homes will support the stabilization of prices and subsequently their reduction.
In the global economy, the moderate improvement that we’ve seen in recent months continued. Forecasts for global economic growth have generally been revised upward recently, and the improvement in the growth rate of world trade continues. The positive momentum was notable in Europe against the background of political developments that reduced the risk to the continued existence of the eurozone and the EU; growth there is becoming entrenched, with continued decline in unemployment, though inflation remains lower than the target. In the US, an improvement in growth is apparent, after first quarter growth disappointed, but there is uncertainty about the government’s ability to implement the economic plans it announced. The Federal Reserve increased, as expected, the federal funds target rate by one quarter of one percentage point, and the pace of future increases is expected to be moderate; the Fed also revealed the details of the program through which it will begin the process of reducing its balance sheet, but did not set a specific date for its start. In Europe and in Japan, the very accommodative monetary policy continues. Financial markets interpreted the ECB’s messages as an indication that the extent of the monetary accommodation is expected to contract, and this was reflected in increased yields on government bonds. With that, the ECB did not give an indication regarding the timing of when it will begin to retreat from the quantitative easing.
After the sharp appreciation in the effective exchange rate over the first few months of the year, the pace of the appreciation moderated: over the past three months, in which the Bank of Israel purchased approximately $3 billion in foreign exchange, there was a nominal effective exchange rate appreciation of one percent, with a relatively sharp change in cross exchange rates—the shekel appreciated against the dollar during this period by more than 3 percent, but weakened against the euro by about 3.5 percent. As we have said in the past, the level of the exchange rate partly reflects the relatively good state of Israel’s economy, reflected in, for example, the current account surplus and relatively high growth. However, in our assessment as well as that of other entities in the market, the shekel is overvalued, a result of the very accommodative policy that some central banks are adopting. The level of the exchange rate weighs on exports, with an emphasis on manufacturing and on the tradable industries in general. Over time, in order to support these industries, the government should adopt policy measures that will increase productivity: improve the business environment, improve human capital, and increase the investment in infrastructure (which in itself, as we showed in the Bank of Israel Annual Report, can contribute to a depreciation in the exchange rate).
The continued monetary contraction in the US, and a change in the trend of very accommodative monetary policy in Europe and in other economies, when it occurs, will on their own serve as a force for the weakening of the shekel. However, the Monetary Committee will act in the foreign exchange market as long as monetary-policy needs warrant it.
The Research Department presented the macroeconomic staff forecast (recall that it is a conditional forecast based on assumptions regarding exogenous variables) to the Monetary Committee, and published it today. In light of the high growth in recent quarters, the 2017 full-year forecast was revised upward, to expected growth of 3.4 percent, similar to the 3.3 percent growth forecast for 2018. The forecast has been revised upward regarding the growth rate of exports over the coming two years, in view of the improvement in world trade. Inflation is expected to enter the target range in approximately a year, although, as noted, it is expected to decline further before returning to rise. The interest rate path in the forecast is the same as what was presented in the previous forecast.
In conclusion, the Bank of Israel’s monetary policy is influenced by developments in the global economy, but it is only directed toward achieving domestic targets. In our assessment, the accommodative policy contributed to the economy growing at a satisfactory pace and to the especially low unemployment rate. With that, for the various reasons I noted, inflation remains below the target, and even if additional central banks will begin to reduce their monetary accommodation, the Monetary Committee intends to maintain the accommodative policy as long as necessary in order to entrench the inflation environment within the target range.
Have a nice summer!