Backgrounds Conditions

Inflation data: The Consumer Price Index (CPI) for September declined by 0.3 percent, below forecasters’ projections for a decline of 0.1 percent, on average. There were marked declines in the food and in the fruit and vegetables components, and no component increased this month. In five of the past six months, the actual CPI reading was lower than the average of the forecasters’ projections. The inflation rate over the preceding 12 months was -0.3 percent, compared with 0 percent over the 12 months ended in August. The tradable goods components of the CPI declined by 2.5 percent over the past 12 months. The rate of increase in components consisting of nontradable products also declined to below the inflation target range, to 0.8 percent.

Inflation and interest rate forecasts: This month, 1-year inflation expectations (seasonally adjusted) derived from the capital market declined sharply to 0.6 percent, and expectations for two years also declined, to 1.0 percent. Private forecasters’ projections for the next 12 CPI readings declined to 0.9 percent, on average. Expectations for the coming 12 CPI readings derived from banks’ internal interest rates declined to 0.5 percent. Expectations for medium and long terms continued to decline this month, by about 15 basis points for long terms and by about 10 basis points for medium terms, compared to last month. Some private forecasters expect some reduction in the Bank of Israel interest rate during the next three months, and this expectation is also indicated in data from the makam and Telbor curves.
Real economic activity: Some monthly indicators of real economic activity have not been updated since the previous Monetary Committee discussion, due to the holidays. Most data which became available this month indicate that due to Operation Protective Edge, activity in the third quarter slowed, and perhaps even declined, although there are signs of recovery in September. Goods exports (excluding ships, aircraft and diamonds) increased moderately, by 1.3 percent, in September, after declining by 6 percent in August, and imports (excluding ships, aircraft, diamonds and fuels) declined by 3.9 percent. The export of other business services (excluding startups) declined by 0.9 percent in July, compared with the peak levels of the second quarter. There was a very slight recovery in the number of tourist entries in September, following the low reached in July–August. The Bank of Israel’s Companies Survey for the third quarter showed a decline in business sector activity, reflected in the fact that the weighted net balance is significantly negative. All industries reviewed in the Companies Survey show negative net balances, with the sharpest decline in hotels’ activity. The business sector Climate Index, based on the Business Tendency Survey conducted by the Central Bureau of Statistics for September, reflects a monthly growth rate of 0.16 percent. This is an improvement compared with the rate of 0.13 percent in August, but is still significantly lower than the rate in the months prior to Operation Protective Edge—0.22 percent to 0.27 percent. The Purchasing Managers Index increased by 7.3 points to 49.9 points in September, the level that distinguishes between contraction and expansion, following a marked decline in July and August. Consumer confidence indices show a mixed picture: The Central Bureau of Statistics index improved in September compared to August, the Bank Hapoalim index declined, and the Globes Index remained virtually unchanged.
The labor market: The number of employee posts declined by 0.3 percent in July compared with the second quarter, with a decline of 1.1 percent in the business sector offset by an increase of 0.7 percent in public services. The number of full time positions declined by about 0.8 percent in July–August compared with the second quarter. Health tax receipts are increasing at a stable rate: receipts in August–September were 5.5 percent higher (in nominal terms) than the same period last year, compared to a year over year increase of 4.8 percent in July-August. Nominal wages increased in May–July by 0.9 percent, and real wages increased by 0.7 percent, compared to February–April (seasonally adjusted data).
Budget data: In January­–September, the deficit in the government’s domestic activity (excluding net credit) totaled about NIS 7.2 billion. This is about NIS 3.6 billion smaller than the deficit in the seasonal path consistent with meeting the 2014 deficit target, as expenditure has been lower than the seasonal path consistent with full budget performance. Ministry expenditures are only 3.4 percent greater in nominal terms than the same period last year. With that, an acceleration in expenditure is expected over the remainder of the year. Domestic revenues from the beginning of the year are about NIS 1.5 billion lower than the seasonal path consistent with the budget forecast. Based on trend data, VAT on gross domestic activity—an indicator of private consumption—increased by about 0.6 percent in the third quarter, compared with the previous quarter.
The foreign exchange market: From the monetary policy discussion on September 21, 2014, through October 24, 2014, the shekel weakened by 4.1 percent against the dollar, and by 2 percent against the euro. In terms of the nominal effective exchange rate, the shekel weakened by 2.8 percent. For the year to date, the shekel has weakened by about 4.1 percent in terms of the effective exchange rate.
The capital and money markets: From the monetary policy discussion on September 21, 2014, through October 24, 2014, the Tel Aviv 25 Index declined by 0.9 percent, a smaller decline than the worldwide trend. Yields in the government bond market declined sharply, mainly against the background of a decline in yields abroad. Yields on the unindexed bond yield curve declined by up to 35 basis points, with a decline in the steepness of the curve. The yield on the 10-year unindexed bond declined by about 35 basis points, to 2.1 percent. The decline in yields on the CPI-indexed curve was more moderate, and reflected a decline in the inflation expectation implied in the medium and long portions of the curve. The yield differential between 10-year Israeli government bonds and corresponding 10-year US Treasury securities remained virtually unchanged, at a negative level of about 15 basis points. Makam yields declined by about 5–8 basis points along the entire curve, and the 1-year yield is 0.17 percent. Israel's sovereign risk premium as measured by the five-year CDS spread remained virtually unchanged at 89 basis points.
The money supply: In the twelve months ending in September, the M1 monetary aggregate (cash held by the public and demand deposits) increased by 24.6 percent, and the M2 aggregate (M1 plus unindexed deposits of up to one year) increased by 7.9 percent.
The credit markets: Total outstanding debt of the business sector increased by about NIS 10.6 billion (1.4 percent) in August, to NIS 781 billion, mostly a result of the depreciation of the shekel against the dollar, which increased the shekel value of debt indexed to and denominated in foreign currency. However, the figure also reflects net debt raised of about NIS 2 billion, mainly in the nonbank market. In September, the nonfinancial business sector issued about NIS 4.1 billion in bonds, compared with a monthly average of NIS 3.6 billion since the beginning of the year. Net new investment in corporate bond mutual funds continued, though at a lower volume than during the first months of the year. Corporate bond market spreads remained low, at a level that may indicate the underpricing of risk in this market. Outstanding household debt increased by about NIS 1.9 billion (0.5 percent) in August, to about NIS 425 billion. The increase derived mostly from continued growth in housing debt, which increased by NIS 1.5 billion. In September, new mortgages taken out totaled NIS 3.9 billion, compared with a monthly average of about NIS 4.3 billion since the beginning of the year. The interest rate on new variable-rate, unindexed mortgages taken out declined in September by 0.17 percentage points, against the background of the decline in the Bank of Israel interest rate. The average interest rate increased by about 0.04 percentage points on new CPI-indexed, fixed rate mortgages, and by 0.14 percentage points on new CPI-indexed, variable rate mortgages.
The housing market: The housing component of the CPI (based on residential rents) remained unchanged in September, after increasing for 7 consecutive months at an average monthly rate of 0.5 percent. In the 12 months ending in September, this component increased by 2.1 percent, and over the course of the year a trend of decline is apparent in its rate of increase. Home prices, which are measured in the Central Bureau of Statistics survey of home prices but are not included in the CPI, declined by 1 percent in July–August. The annual rate of growth in prices moderated, such that over the 12 months ending in August, home prices increased by 5 percent, compared with an increase of 6.5 percent in the 12 months ended in July. The number of transactions in the housing market continues to decline sharply. The volume of such transactions in the second quarter was about 20 percent lower than in the first quarter, and partial data show that there was a similar decline in the third quarter. The decline encompassed all types of transactions, but it appears that it was especially sharp for homes priced at up to NIS 1.6 million. In the 12 months ended in July, there were about 45,000 building starts.
The global economy: Concern about further moderation in the global economy increased this month, against the background of an increase in uncertainty and in volatility on various markets. The IMF reduced its global growth forecast for 2015 by 0.2 percentage points, to 3.8 percent. The forecast for world trade growth was reduced by 0.3 percentage points, to 5 percent, concurrent with a decline in world trade in August. In the US, the recovery in growth continued, but in the background are a significant number of downside risks to the forecast. Despite the improvement in the labor market, most of those joining the labor force are earning low salaries, so that salaries increased at a moderate pace and continue to weigh on a recovery in personal consumption. The dollar continues to strengthen vis-à-vis the basket of major currencies (DXY), which may also weigh on the recovery of the US economy. The global economic environment and comments by leading Fed officials led to a change in market estimates of the timing of the start of interest rate increases in the US, which is now expected to be delayed by a few months to around October 2015. In the eurozone, the flow of disappointing data continues. Germany’s economy has weakened, and the French and Italian economies are having difficulty recovering. The IMF reduced its forecast for eurozone growth in 2015 by 0.2 percentage points, to 1.3 percent. Companies surveys and expectations indices continue to weaken and to indicate negative sentiment. The unemployment rate remains high, at 11.5 percent. The annual inflation rate declined to a new low of 0.3 percent, and concerns of deflation are increasing. The ECB published the details of an asset purchasing program, which were received with some disappointment in the markets since it did not include quantitative targets. In Japan as well, most of the data published this month were disappointing, and indicated the lack of recovery since the VAT increase in April. The Bank of Japan repeated its commitment to adopt accommodative policy as long as necessary. The growth rate in the Chinese economy is stabilizing, and the composition of growth improved recently, while in the background, the decline in real estate prices continued. In Brazil there is continued instability, while data for India indicate a mixed trend. Concerns over the weakening global economy led to sharp fluctuations in stock markets, and the MSCI World index declined by about 3.5 percent at the end of the period. Due to the concern over weakness in global activity, and despite the geopolitical instability in Ukraine and the Middle East, energy prices continue to decline sharply. The price of a barrel of Brent Sea crude oil declined by 15 percent to $86. In contrast, agricultural commodity prices increased by 5 percent this month.
The main considerations behind the decision
The decision to keep the interest rate for November 2014 unchanged at 0.25 percent is consistent with the Bank of Israel's monetary policy, which is intended to return the inflation rate to within the price stability target of 1–3 percent a year over the next twelve months, and to support growth while maintaining financial stability. The path of the interest rate in the future depends on developments in the inflation environment, growth in Israel and in the global economy, the monetary policies of major central banks, and developments in the exchange rate of the shekel.
The following are the main considerations underlying the decision:
  • The inflation environment continued to decline this month. The inflation rate measured over the preceding 12 months was negative 0.3 percent. Inflation expectations for the coming year, from various sources, declined to below the lower bound of the inflation target range, and two-year expectations are at the lower bound. Expectations for longer terms declined as well, though they are near to the midpoint of the target range.
  • Most indicators that became available this month signal that activity in the third quarter slowed, and perhaps even declined. Most of the slowdown in activity derives from Operation Protective Edge. The Companies Survey points to a decline in activity in the third quarter in all industries, primarily in tourism. There was no substantial decline in confidence indices despite Operation Protective Edge, and there was improvement in the Purchasing Managers Index.
  • In light of the reductions in the Bank of Israel interest rate, and the strengthening of the dollar worldwide, the shekel weakened by 2.8 percent this month in terms of the nominal effective exchange rate, and it has weakened by about 4.1 percent since the beginning of the year. Continued depreciation will support a recovery in exports and in the tradable sector as a whole, and is expected to contribute to returning the inflation rate to within the target range.
  • Concern increased this month of a further moderation in the global economy, against the background of the increased uncertainty and volatility in various markets. Disappointing data were received this month in the eurozone, with an emphasis on its larger economies. In the US, the recovery in growth continues, though there are downside risks to the forecast. Based on market assessments, the timing of when the Fed will begin to raise the federal funds rate has been deferred to around October 2015.
  • The sharp decline in the number of transactions in the housing market continues, and there is a moderation in the rate of mortgages being taken out. Home prices declined by 1 percent in July-August, and their rate of increase over the 12 months ending in August slowed to 5 percent. It is difficult to assess the response that will occur when the uncertainty regarding the zero-VAT law is removed.
  • Net new investment in corporate bond funds continues, though at relatively low volumes. Spreads in this market continue to indicate an apparent underpricing of risks.
The Monetary Committee is of the opinion that the effects of the recent interest rate reductions, which brought the interest rate to a level of 0.25 percent, have not yet been fully reflected in activity and in inflation, and in light of that decided to keep the interest rate unchanged this month.
The Bank of Israel will continue to monitor developments in the Israeli and global economies and in financial markets. The Bank will use the tools available to it and will examine the need to use various tools to achieve its objectives of price stability, the encouragement of employment and growth, and support for the stability of the financial system, and in this regard will continue to keep a close watch on developments in the asset markets, including the housing market.
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The minutes of the monetary discussions prior to the interest rate decision for November 2014 will be published on November 10, 2014.
The decision regarding the interest rate for December 2014 will be published at 16:00 on Monday, November 24, 2014.