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Previous Inflation Reports
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Inflation Report 2004, July - December
Letter of the Acting Governor, Dr. Meir Sokoler

Jerusalem, January 2005

The Inflation Report for the second half of 2004 is submitted to the government, the Knesset, and the public as part of the process of periodic monitoring of the course of inflation and adherence to the inflation targets set by the government, and is intended to increase the transparency of macroeconomic policy. The transparency of policy, fiscal and monetary, is important as a means of increasing the confidence in the economy of Israeli and foreign individuals and companies, and contributes to the proper functioning of the markets and the economy as a whole.

The Consumer Price Index (CPI) rose by 1.2 percent in 2004, within the target range of price stability, i.e., a rise of between 1 percent and 3 percent, set by the government for 2003 onwards. Thus the monetary policy conducted by the Bank of Israel in the last six years succeeded in establishing the achievement of the disinflation process pursued during the last decade and in maintaining price stability, according to the government’s targets. In the last six years, since 1999, annual inflation in Israel has averaged 1.4 percent, within the price-stability target range. This was achieved despite the fact that inflation during this period was, and still is, more volatile than in other countries in which price stability prevails. As price stability was becoming more firmly based, the financial markets, including the foreign currency market, continued to be stable. At the same time, as part of the Bank of Israel’s monetary policy, the short-term nominal interest rate was reduced during the last two years, to reach a level of 3.5 percent in February 2005, a historically low level. This took place against the background of stable conditions reflected by, among other things, inflation expectations at a level consistent with the price stability range, and sometimes even with its lower half. This process of reducing the local-currency interest rate, as the rate in the US has started rising recently, led to the contraction of the interest-rate differential between the NIS and the dollar to less than 1.5 percentage points in February 2005.

GDP increased by a rapid 4.2 percent and business-sector product by 6 percent in 2004 (annual averages), against the backdrop of economic recovery world wide and a certain easing of the security situation. This growth was accompanied by a rise in employment, mainly in the business sector, reflecting a moderate downward trend in unemployment, from a peak of 10.9 percent in the third quarter of 2003 to 10.2 percent in the third quarter of 2004, alongside a rise in the participation rate in the labor force and a rise in labor productivity. These welcome indications were based on macroeconomic policy which focused on strict fiscal discipline and adherence to long-term budget targets, structural reforms, infrastructure investment, and stability with regard to prices and in the financial markets.

The major objectives currently confronting macroeconomic-policy makers is to secure a firm base for long-term growth and to deal with the problem of poverty and social gaps. This policy must rest on a fiscal strategy designed to reduce the weight of the public sector in the economy, transferring resources into business-sector activity, and continuing with the monetary strategy of price stability. In this context it is important to implement the reform of the capital market according to the recommendations of the Bachar Committee, increasing competition in the financial markets, broadening the range of sources of finance, and reducing the extent of conflict of interests in the banking system. At the same time the structural reforms that have started should continue at a faster pace, and those planned should be implemented, in the public sector, the labor market, the ports, the education system and the infrastructures, as well as the privatization process.

Together with these important steps, special attention must be given to reducing poverty and social gaps. These problems can only be tackled effectively on the basis of a policy that encourages a rise in the rate of participation in the labor force, increased retraining among the weaker segments, improvement in the education system, and focused support of the weak and elderly and other groups in the population unable to participate in the labor force.

The time has come to enact a modern Bank of Israel Law that will clearly set the maintenance of price stability as the prime objective of the central bank vis-à-vis other possible objectives. This Law should clearly state the Bank’s operational independence and should establish a Monetary Policy Committee (MPC), headed by the Governor, that will make decisions regarding the policy and management of the Bank of Israel. Such legislation, according to the standards accepted with regard to central banks throughout the world, will ensure the Bank’s ability to meet the goals set before it.

The Inflation Report was prepared in the Bank of Israel within the framework of the Senior Monetary Forum, headed by the Governor. The Forum is the inter-departmental team––whose members include the Deputy Governors and the heads of the Monetary, Research, Foreign Currency, and Foreign Exchange Activity Departments-which discusses monetary policy issues.

Meir Sokoler         

Acting Governor       



The Consumer Price Index (CPI) went down by 0.2 percent in the second half of 2004, after rising by 1.4 percent in the first half. The cumulative annual rise in prices came to 1.2 percent, close to the lower limit of the price-stability target range, and followed a price drop of 1.9 percent in 2003.


In the first half of the year the Bank of Israel continued reducing the monetary interest rate until April, and then halted the process, and until November the interest rate stood at 4.1 percent. This took place against the background of price rises in the second quarter of the year, indicators suggesting that expected inflation was within the target range, and concern regarding the effect on the foreign currency market of the narrowing of the interest-rate differential between the NIS and the dollar with the rise in the interest rate in the US. As more data became available in the third quarter indicating a slowdown in the growth rate, increasing appreciation of the NIS against the dollar with the weakening of the dollar worldwide, and falling long-term yields, the Bank of Israel responded by cutting the interest rate for December 2004, and January and February 2005. The Bank of Israel interest rate in February 2005 stood at 3.5 percent.


The background to the change in prices and to monetary policy was the responsible fiscal policy implemented during the year, reflected by the cut in public expenditure, and by a deficit that was significantly lower than that in 2003, and even lower than the target for the year. The compatibility of the tight fiscal policy with the expansionary monetary policy helped to boost the public's confidence in the overall macroeconomic policy, thereby enabling the interest rate to be reduced further. The global economic growth that led to accelerated domestic growth, and the political and economic calm throughout the year also formed part of the background. All the above led to stability in the financial markets, which was supported by the reforms carried out in the last few years, in particular the removal of the ceiling on the issue of Treasury bills and the greater flexibility of the exchange-rate band.


The moderate rise in prices over the year as a whole and their reduction in the second half were related to changes in the exchange rate––depreciation of the NIS against the dollar in the first half-year, that served to raise prices, and appreciation against the dollar in the second half, that tended to lower them. The level of activity did not put upward pressure on prices, despite the rapid rate of economic growth; this was due to excess capacity. Acting in the opposite direction, the rise in world fuel prices exerted upward pressure on prices in Israel.


In the second half of the year the exchange rate of the NIS showed low volatility with a trend of appreciation, and it appreciated by 4.2 percent against the dollar and by 0.7 percent against the currency basket. The relative stability of the foreign currency market was the result of a balance between the forces that affect the exchange rate: those acting to weaken the NIS were opposed by domestic and global factors that tended to strengthen it.


The effect of the cumulative reductions in the interest rate during the last two years and the low level of short-term real interest currently prevailing are expected to raise the rate of inflation in 2005. Based on assessments of inflation for the coming year derived from the capital market, private forecasters predictions, and the Bank of Israel's Companies Survey, inflation is expected to rise to between 1 percent and 2.5 percent. The assessment in the Bank of Israel is that in order to keep within the target range of price stability during the next twelve months a certain rise in the interest rate will be required, the extent of which will depend among other things on interest-rate developments world wide.

The full document, in PDF file -

Previous Inflation Reports:

   Inflation Report 2004 (January-June)
   Inflation Report 2003 (July-December)
   Inflation Report 2003 (January-June)
   Inflation Report 2002 (July-December)
   Inflation Report 2002 (January-June)
   Inflation Report 2001 (July-December)
   Inflation Report 2001 (January-June)
   Inflation Report 2000 (July - December)
   Inflation Report 2000 (January - June)
   Inflation Report 1999 (July - December)
   Inflation Report 1999 (January - June)
   Inflation Report 1998 (January - June)
   Inflation Report 1997