The decision to leave the interest rate for November unchanged after reducing it for October is in line with monetary policy aimed at stabilizing the rate of inflation within the price stability target range of 1-3 percent over the coming 12 months, and is intended to support growth while preserving financial stability.
( Communicated by the BOI Office of the Spokesperson and Economic Information)
The current interest rate decision was made by the Monetary Committee in accordance with the new Bank of Israel Law. The Monetary Committee has six members. Three are from the Bank – Governor of the Bank of Israel Prof. Stanley Fischer, who serves as chairperson of the committee, Deputy Governor Dr. Karnit Flug, and Barry Topf, Senior Advisor to the Governor. The other three members of the committee are from the public – Prof. Reuben Gronau, Prof. Rafi Melnick, and Prof. Alex Cukierman.
Inflation data: The Consumer Price Index (CPI) declined 0.2 percent in September, below forecasts which on average predicted no change, and within the seasonal path consistent with achieving the inflation target. The food prices component of the index continued to decline, among other reasons against the background of the social protest. This month, the rate of inflation over the past 12 months, as measured by the change in the CPI, entered the target range (1-3 percent per year) and is now 2.9 percent. The rate of inflation, seasonally adjusted, over the past seven months has been around the lower limit of the inflation target range.
Inflation and interest rate forecasts: Inflation expectations as calculated from the capital markets, which reached around 2 percent toward the end of September, declined in October and are at 1.6 percent on average.
Expectations fell primarily for the short term – for the medium and longer periods expectations remained steady at 2.3 percent. Forecasters’ inflation predictions for the next twelve CPI readings were 2.2 percent on average, slightly below last month’s average. The decline in expectations of inflation took place against the background of continued expectations for a slowdown in growth world wide and in Israel, as well as the lowering of prices by retail chains and service providers, influenced by the social protest against the high cost of living. At the same time, forecasts of the Bank of Israel interest rate continued to fall. Based on the Telbor (Tel Aviv Inter-Bank Offered Rate) market, the Bank of Israel interest rate one year from now is expected to be 2.7 percent, down from 3 percent a month ago, and the average of forecasters’ predictions is that it will be 3 percent, down from 3.15 percent a month ago. Most forecasters expect the Bank of Israel to leave the interest rate for November unchanged, and on average they expect the interest rate to be reduced by 0.3 percent in the next three months.
Real economic activity: Economic indicators that became available this month support the assessment of recent months that the rate of growth of the economy is lower than that of the first quarter of 2011. The growth of both domestic demand and goods exports declined. Based on foreign trade figures (seasonally adjusted) industrial exports declined around 4.3 percent in the third quarter, compared with the second quarter. In contrast, imports were mostly unchanged, primarily due to an increase in imports of investment goods. In September, the goods trade deficit continued to widen, as it had over recent months. The Bank of Israel’s Companies Survey for the third quarter shows that the economy continues to expand, though at a more moderate pace than in previous quarters. With that, in most industries the expectations for the fourth quarter range from a freeze in activity to a moderate drop in activity. The Central Bureau of Statistics survey of business trends as well as the Globes and the Bank Hapoalim consumer confidence indices point to a decline in the public’s planned consumption. The Purchasing Managers Index, compiled by Bank Hapoalim and the Israel Purchasing and Logistics Managers Association, fell sharply and in September was below 50. Tax receipts in September were 4 percent lower than forecast, a continuation of the slowdown that began in April.
The labor market and wages: Labor market data indicate a high level of employment and a low unemployment rate. The rate of growth of the number of employed has moderated in recent months. The trend rate of unemployment for July was unchanged at 5.4 percent. The number of Israeli employee posts (seasonally adjusted) increased by 2 percent in May-July, in annual terms, compared with the preceding three months. The nominal wage rose in May-July by 1.5 percent, compared with the three previous months (seasonally adjusted), and the real wage was unchanged. In September, health tax receipts, which provide an indication of wage payments in that month, were 9 percent higher (preliminary estimate), in nominal terms, than in September 2010 (excluding the effect of legislative changes).
The Bank of Israel Research Department staff forecast: According to the Research Department staff forecast (from September), inflation over the four quarters ending in the third quarter of 2012 will be 2.3 percent, and the average interest rate for 2012 will be 3 percent. GDP growth for 2011 is forecast to be 4.7 percent, and 3.2 percent in 2012. The assessment is based on, among other things, a lowered International Monetary Fund (IMF) forecast for global growth and world trade. This month the Research Department examined the possible effect on Israel’s economy of a scenario in which global growth is 1 percentage point lower than the base scenario. If the lower growth scenario develops, GDP growth in Israel is forecast to be about 0.5 percentage points lower in 2012 than in the base scenario. Inflation over the four quarters ending in the third quarter of 2012 is forecast to be 0.8 percentage points lower than in the base scenario, and the average interest rate for 2012 is expected to be 1 percentage point lower than in the base scenario.
Budget data: Government domestic revenues for the year to date through September were 3.1 percent lower than the seasonal path of the budget forecast, due to a continued slowdown in indirect tax receipts, which began in April. The overall government deficit (excluding net credit) in the year to date was NIS 9.7 billion, compared to a deficit of NIS 14 billion in the corresponding period of the year before. Developments in government activity so far indicate that tax revenues will be slightly lower than the budget forecast, and the budget deficit for the full year of 2011 will be around the deficit ceiling set by law – 3 percent of GDP.
The foreign exchange market: From the previous monetary policy discussion held on September 25, through October 21, the shekel appreciated by about 1.8 percent against the dollar, in line with the general trend, but at a moderate level compared with the performance of currencies of developed countries. In contrast, the shekel was essentially unchanged against the euro (depreciation of 0.02 percent). The shekel strengthened by about 0.8 percent in terms of the nominal effective exchange rate. The rate of participation by nonresident investors in foreign currency trading was 26 percent in October, compared with 32 percent in September, while the average for the year to date in 2011 is 34 percent.
The capital and money markets: From the previous monetary policy discussion held on September 25, through October 21, the Tel Aviv 25 Index increased by 5.9 percent, with relatively high volatility, similar to the trend on most stock markets around the world.
The government bond market responded with declining rates for most maturities. Returns declined 10-16 basis points across most of the yield curve of unindexed bonds, and yields on CPI-indexed government bonds declined by up to 6-12 basis points for most maturities. The yield gap between Israeli 10-year government bonds and equivalent 10-year US Treasury securities contracted to about 250 basis points, from 290 basis points in the previous month.
Makam yields fell by up to 25 basis points across the yield curve, as the yield for one year fell during the period from 2.98 percent to 2.8 percent – against the background of the interest rate cut by the Bank of Israel last month, and expectations of similar moves in coming months. Withdrawals from mutual funds specializing in corporate bonds continued this month, although at a slower pace than that in the previous month.
Over the period as a whole, Israel’s sovereign risk premium as measured by the five-year CDS spread declined, and narrowed to 160 basis points from last month’s 218 basis points. The Tel-Bond indices rose around 2 percent.
The money supply: In the twelve months ending in September, the M1 monetary aggregate (cash held by the public and demand deposits) increased by 0.5 percent, and the M2 aggregate (M1 plus unindexed deposits of up to one year) increased by 13.1 percent.
Developments in the credit markets: The balance of outstanding debt of the business sector increased in August by 1.5 percent, to NIS 768 billion. Outstanding credit to households increased by 0.4 percent in August, to NIS 359 billion. Of the credit to households, outstanding housing credit rose 10.9 percent in the twelve months ending in August, to NIS 255 billion, compared with an 11.8 percent increase in the twelve months to July. The volume of new housing credit granted in the twelve months ending in September was slightly lower than in the twelve months ending in August – a continuation of consecutive declines since the record high set in May. The share of unindexed floating rate mortgages extended in September rose to 26.8 percent, from 26.1 percent in August. These percentages are significantly lower than the record levels of the first quarter of 2009 – about 75 percent on average. The interest rates on floating rate mortgages, both CPI-indexed and unindexed, continued to increase in August, while the interest rates on fixed rate CPI-indexed mortgages declined.
The housing market: Activity in the construction industry continues to be strong. The number of starts in the twelve months to July reached 42,910, compared with 42,059 the month before, and the number of completions was 33,138, compared with 33,740 the previous month (Ministry of Construction and Housing figures).The number of homes available for sale continued to increase, and in June-August was on average 9.1 percent higher than in the three preceding months (original data).
The construction sector continued to expand in the third quarter, according to figures from the Bank of Israel’s Companies Survey, and expectations in the sector are for continued growth in activity in the fourth quarter as well.
Housing prices reflected in the housing index, which is based mainly on renewed rental contracts and which is included in the CPI, continued to increase at a relatively rapid pace, rising 0.9 percent in September, and by 5.5 percent in the past twelve months, and prices are expected – according to the Research Department forecast – to continue to increase at a similar pace in the coming year. Home prices, which are published in the Central Bureau of Statistics survey of home prices but are not included in the CPI, increased at a monthly rate of 0.8 percent in July and August, after rising 0.4 percent in June and July. The annual rate of increase in home prices remains high and relatively stable. In the twelve months ended in July home prices increased by 12.1 percent; compared with a 12.3 percent increase in the June figure and a 12.1 percent increase in May – this follows levels of around 20 percent in 2010.
The slowdown in the rate of increase in home prices comes against the background of the continued increase in the number of building starts, the lagged effect of the increase in the interest rate, measures introduced by the Bank of Israel affecting mortgages, and steps taken by the Ministry of Finance in real estate taxation. The effect of these moves is expected to continue and be evident going forward.
The global economy: Uncertainty about the continuation of the global economic recovery increased this month, primarily against the background of difficulties in major economies, the financial crisis in Europe, and lack of clarity regarding rescue plans developing in Europe. Growth forecasts for Europe for 2011 and 2012 were revised down. The base scenario is for a standstill in Europe and low growth in the US. There are also the first signs of moderating economic activity in emerging markets.
Europe continues to be the focus of risk factors – the probability of negative growth, even in core economies, increased significantly, and recently, the growth forecast in Germany for 2012 declined by half, to 0.8 percent. Concern regarding a severe financial crisis remained high, due to risk spreading to leading banks in Europe, liquidity difficulties in the banking system, and lowered ratings of leading banks in the world. These background conditions led policy makers in Europe to announce a wide ranging aid plan, and led major central banks (the Fed, ECB, and BOE) to undertake further measures of monetary easing. With that, the aid plans developing in Europe and relatively good macroeconomic figures in the US, led to gains in main stock indices.
The main considerations behind the decision
The decision to leave the interest rate for November unchanged after reducing it for October is in line with monetary policy aimed at stabilizing the rate of inflation within the price stability target range of 1-3 percent over the coming 12 months, and is intended to support growth while preserving financial stability. The path of the interest rate in the future depends on developments in the inflation environment, growth in Israel, the global economy, the monetary policies of major central banks, and developments in the exchange rate of the shekel.
Inflation expectations for the coming 12 months, both those calculated from the capital market and those of forecasters, continued to decline within the inflation target range and are currently 1.7 percent and 2.2 percent, respectively. The rate of inflation over the previous 12 months entered the target range in September, for the first time since December 2010, and is currently 2.9 percent. The rate of inflation, seasonally adjusted, over the past seven months has been around the lower limit of the inflation target range.
Economic indicators that became available this month indicated that local economic activity continued to expand, but at a slower pace than in 2010 and the first quarter of 2011. The slowdown in the growth of the local economy was primarily a result of moderation in global demand and its impact on exports, but some weakness also began to be evident in domestic demand.
Concerns of a negative turnaround in the eurozone remained, primarily in light of the difficulties in formulating a rescue plan for countries suffering debt crises. In the US, while concerns of a negative turnaround have not dissipated, recent figures on activity were better than expected. With that, the level of uncertainty regarding developments in the global economy remains especially high, and clearly impacts on uncertainty regarding developments in Israel’s economy.
The negative turnaround in Europe and the slow growth in the US have led to the markets not pricing in an interest rate increase over the coming year by the central bank of any large advanced economy. The Federal Reserve has said that the fed funds rate is expected to remain at its near zero level until at least the middle of 2013. The Fed and ECB continued monetary expansion programs.
The rate of increase in home prices over the twelve months which ended in August remains relatively stable at a high level of over 12 percent, though low compared with last year’s 20 percent levels. With that, the sustained increase in building starts, the lagged effect of the increase in the interest rate, measures taken by the Bank of Israel with regard to mortgages, and changes in real estate taxation introduced by the Ministry of Finance, are expected to continue to contribute to moderation in home prices over the coming year.
Maintaining the interest rate at its current level leaves the Bank of Israel room to respond to events in the global and local economies.
The Bank of Israel will continue to monitor developments in Israel’s economy and the global economy and in the financial markets. The Bank will use the tools available to it to achieve its objectives of price stability, the encouragement of employment and growth, and support for the stability of the financial system, including keeping a close watch on developments in the assets market, and especially in the housing market.