The Monetary Policy Report for the first half of 2011 (the period reviewed in this
report) is submitted to the government, the Knesset, and the public as part of the
process of assessing the inflation rate in relation to the inflation target set by the
government. The Report was prepared in the Senior Monetary Forum of the Bank of
Israel, headed by the Governor, the forum in which the Governor makes decisions on
the interest rate.1
The Consumer Price Index (CPI) increased by 2.2 percent over the course of the first
half of 2011. Contributing to the large increase (an annualized rate of 4.4 percent) was
an increase of 3.5 percent in the housing component (representing rentals), as well as
the food (4.4 percent) and energy (6.6 percent) components. The rise in prices during
the period reviewed was affected by domestic factors, primarily housing, as well as by
external factors—commodity and energy prices. In each month of the period
reviewed, the price increase over the previous 12 months exceeded 3 percent—the
upper limit of the 1–3 percent inflation target range. However, monthly figures
(seasonally adjusted) show that in the last four months there has been a drop in the
rate of price increases, compared with the months preceeding them.
The global recovery from the crisis of 2008 continues, with advanced economies
growing slowly and emerging economies growing rapidly. According to an
International Monetary Fund (IMF) forecast for 2011, advanced economies are
expected to grow by 2.2 percent and emerging and developing economies are seen
growing by 6.6 percent. In the period surveyed, commodity and crude oil prices rose,
raising with them inflation forecasts for 2011 to 2.6 percent in advanced economies
and 6.9 percent in emerging economies. With regard to interest rates, increases are not
expected in the US in the coming year. In the eurozone, the European Central Bank
(ECB) raised the interest rate for April and July by 0.25 percentage points each time,
but there has been growing uncertainty there recently regarding the rate of growth and
the future interest rate path; this stems from the increasing concerns over the debt
crisis in several European countries which could also have an impact on global
financial stability. The expanding national debt in most advanced economies and the
high rate of inflation in emerging economies are expected to lead to policies of fiscal
restraint (in advanced economies) and monetary tightening (in emerging economies),
which may slow global growth. One of the expressions of these expectations is,
apparently, a drop in prices of financial assets around the world in the period
surveyed.
In the Israeli economy, the recovery in real economic activity and decline in
unemployment continued in the first quarter of 2011. Growth was based on an
increase in investment, as well as in exports, which were influenced by expanding
global trade. Indicators for the second quarter point to a continued expansion of
business activity, albeit at a slower pace than the first quarter.
In the period surveyed, prices of financial assets—mainly stocks and corporate
bonds—fell, in line with similar developments of equity prices around the world.
Nonetheless, house prices continued to rise in Israel—by 3.8 percent during the first
four months of the year, and by 13.7 percent between April-May 2010 and April-May
2011. In light of the continued increase in the volume of variable rate mortgages, and
in order to prevent the possibility of decline in the stability of banks, as of May 2011
the Bank of Israel limited the variable rate component to one third of each mortgage.
A reporting requirement was also imposed on the banks, obliging them to advise
borrowers who had already taken out housing loans at variable rates as to the effects
of an increase in interest rates on their monthly payments.
In January, there was a marked depreciation of the shekel, apparently as a result of the
growing instability in various Middle East countries, and as a result of steps taken by
the Bank of Israel and the Ministry of Finance (see below). Later in the period
surveyed, the appreciation of the effective exchange rate of the shekel resumed, due in
part to the interest rate gap vis-א-vis the US and the eurozone. Overall, the shekel
appreciated 0.8 percent during the period. In order to moderate the appreciation of the
shekel, the Bank of Israel continued to buy foreign currency. At the same time, in
order to moderate speculative short-term capital movements and increase financial
stability, at the end of January, the Bank of Israel imposed on banking corporations a
reserve requirement of 10 percent against nonresident transactions in foreign currency
derivatives. The Bank of Israel also reported the imposing of a reporting requirement
on transactions in foreign currency derivatives, and a reporting requirement on
nonresident transactions in makam and short-term government debt, which came into
effect at the beginning of July; this in order to track the entrance of capital into the
economy. At the same time, the Ministry of Finance canceled nonresident investors'
capital gains tax exemption in investments in makam and short term government
notes, in order to moderate speculative capital flows.
During the period surveyed, the Bank of Israel accelerated the pace of interest rate
hikes. The interest rate both for February and for March was raised 0.25 percentage
points, the interest rate for April was raised 0.5 percentage points, and the interest rate
for June was raised 0.25 percentage points, for a cumulative rise of 1.25 percentage
points during the period, to a level of 3.25 percent in June. The reasons for the
increases were the rate of inflation, measured over the previous twelve month period,
which throughout the period was above the upper limit of the target range, the
relatively high level of inflation expectations (for the next twelve months), both by
forecasters and as derived from the capital market, as well as the continued economic
growth, and the continued rapid rise in house prices. At the same time, the Bank of
Israel continued to operate in the foreign currency market in order to moderate the
appreciation pressures on the shekel. Toward the end of the period surveyed, the
possibility of some slowdown in economic activity developed, and economic and
financial uncertainty increased greatly, primarily in light of global developments and
the regional geopolitical situation. Signs were also seen of a possible moderation in
the rate of inflation. Against this background, the Bank of Israel kept the interest rate
for July and August unchanged.
The Bank of Israel Research Department forecasts that Israel's economy will grow 4.8
percent in 2011 and that the unemployment rate will fall to an average for the year of
slightly below 6 percent (down from 6.6 percent in 2010). Inflation, as measured by
the change in the CPI, over the next four quarters (beginning in the third quarter of
2011) is expected to decline to 2.9 percent, and over the course of the second half of
2012 to remain within the target range. The Research Department estimates that the
Bank of Israel interest rate will rise gradually to a level of 3.9 percent in the second
quarter of 2012. According to the forecast, the key contributing factors to the
increases in prices, and the increase in the interest rate, during the coming year are
expected to be a continued rise in rents and the high level of prices of commodities
and energy, which are expected to remain in place over the course of the year.
The Bank of Israel will continue to follow developments in Israel and worldwide, and
to conduct policies which support growth and financial stability, at the same time as
striving to return inflation to within the target range (expected, according to the
Research Department staff forecast, during the course of 2012). The extent and timing
of interest rate adjustments will be set according to inflation developments, the
sustainability of growth in Israel and abroad, and developments in the exchange rate
of the shekel, in asset prices, and in interest rates by leading central banks.
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1 Previously the Inflation Report. The name is changed to accord with the term in the new Bank of
Israel Law that calls for a Periodic Report on Monetary Policy to be submitted by the Monetary
Committee not less than twice annually. When the Monetary Committee is appointed, in accordance
with the new Bank of Israel Law (5770-2010), interest rate decisions will be made by the Committee,
and it will present the Monetary Policy Report.
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Stanley Fischer
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Governor, Bank of Israel
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Summary*
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Inflation:
In the first six months of the year, the Consumer Price Index (CPI)
increased by 2.2 percent, and on a seasonally adjusted basis3 it increased slightly
less, by 1.9 percent (which is an annualized rate of 3.9 percent). The main factors
behind the higher index were rises in the price of food, energy, and housing
(rentals). The increase in the rate of inflation, on a seasonally adjusted basis, was
not uniform through the first half of the year. The inflation rate on an annualized
basis was higher than the upper limit of the target inflation range in the first two
months of the year, while in the months of March through June it was within the
target inflation range. The pace of inflation over the previous 12 months, as well
as 12 month forward inflation expectations, were above the upper limit of the
inflation target range in each of the first six months. In June, at the end of the
period surveyed, inflation expectations began to decline, and in July they dropped
slightly below the upper range of the inflation target range.
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The global economic environment:
During the course of the period reviewed
(the first half of the year) most countries in the world recorded positive growth,
and this found expression in an increase in world trade. With that, against the
background of high debts in some advanced economies, along with a rising rate of
inflation in emerging economies, policies of fiscal and monetary restraint are
expected. These policies are liable to slow the pace of global growth. The
International Monetary Fund (IMF), in its most recent survey, noted that in its
opinion, growth forecasts for 2011 and 2012, which will be published over the
coming months, will be revised downward. Due to the increase in the pace of
inflation, emerging economies continued to raise monetary interest rates. In
contrast, the US is only expected to raise the fed funds rate at the end of 2012. In
the eurozone, the interest rate was raised twice since the beginning of the year, in
April and July. With that, in light of the debt crisis in several countries in Europe,
the pace of interest rate hikes in the eurozone is expected to be moderate.
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Real economic activity:
Economic activity continued to expand in the first
quarter of 2011, and GDP grew 4.6 percent (annualized rate, seasonally adjusted).
The increase was contributed to primarily by a 26.1 percent increase in investment
in fixed assets, and a 12.0 percent increase in exports. Indicators of second quarter
economic activity point to continued expansion, albeit at a more moderate pace.
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Exchange rate:
The nominal effective exchange rate reflected significant
depreciation of the shekel in January, against the background of geo-political
uncertainty in Arab countries, and policy measures by the Bank of Israel and the
Ministry of Finance. The shekel then continued its appreciation, similar to its
trend in 2010. The appreciation trend continued, among other things, against the
background of a widening interest rate gap between Israel and developed
economies. Bank of Israel activities in the foreign currency market and policies
intended to restrain the inflow of short term capital into Israel weakened the
shekel appreciation pressures. By the end of the first half of the year, the shekel
showed a moderate appreciation of 0.8 percent.
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Financial markets:
In the first half of the year, against the background of
increasing uncertainty in the world and rising interest rates in the economy, equity
prices reversed course and they began to decline. Yield spreads between CPIindexed
corporate bonds and CPI-indexed government bonds responded with a
delay to developments in financial markets, and despite widening recently, they
remain low. The expansion of credit to the business sector continues. According to
the Bank of Israel Companies Survey, it appears that companies are not facing
credit constraints.
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Mortgages and house prices:
House prices continued to rise at a rapid pace. In
the first four months of the year, the index of house prices rose 3.8 percent, and in
the past 12 months it rose 13.7 percent4. The rapid pace of increase of home prices
is expressed in the widening gaps between house prices and rental levels and
between house prices and average wage levels. In light of the continuing rise in
the volume of variable rate mortgages, the Bank of Israel limited, beginning in
May 2011, the proportion of a mortgage at variable rate interest. In addition, the
directive imposes on the lenders a disclosure requirement, according to which they
must notify customers who took out a mortgage with a variable interest rate, based
on the prime interest rate, not indexed to the CPI. This was with the goal of
increasing banks' and the public's awareness of the consequences of a rise in the
interest rate on the ability of mortgage borrowers to repay their loans.
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Monetary policy:
During the first half of 2011, the Bank of Israel accelerated the
pace of interest rate hikes. The Bank of Israel raised its interest rate during this
period by a total of 1.25 percentage points, to a level of 3.25 percent. The pace of
inflation over the previous 12 months, and inflation expectations above the upper
limit of the target range, the rapid growth of real local economic activity and the
increase in house prices all supported an increase in the monetary interest rate in
order to return inflation to within the target range and maintain financial stability.
At the same time, the Bank of Israel operated in the foreign currency market in
order to restrain the appreciation pressures on the shekel. Bank of Israel activity in
the foreign currency market included purchase of foreign currency, and the
publication of macro-prudential policy directives, including imposing on bank
corporations a reserve requirement of 10 percent against nonresident transactions
in foreign currency derivatives, and imposing a reporting requirement on various
transactions.
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Forecast:
The Research Department staff forecast is that inflation in the next
twelve months will be 2.9 percent, slightly below the upper limit of the inflation
target range. The inflation rate over the next twelve months' being at the upper
limit of the target inflation range is explained by the continued rise in the housing
component (rents) and stronger demand, as well as by the increases in recent
months in the prices of commodities and energy. The economy is expected to
grow at 4.8 percent in 2011 and at 3.9 percent in 2012. The forecast is that the
interest rate will rise gradually to about 3.9 percent over the next year, as part of
Bank of Israel policies to return inflation to within the target range.
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The monetary regime within which the Bank of Israel operates is aimed at achieving price stability,
defined as an inflation rate of between 1 percent and 3 percent a year. (For details see Box 1 in the
Bank of Israel Inflation report No. 17, July–December 2005.) |
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