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23.8.2010
 
The Bank of Israel keeps the interest rate for September 2010 unchanged at 1.75 percent
 
The Bank of Israel announces that the interest rate for September 2010 will remain unchanged at 1.75 percent.
 
Background conditions
Inflation data: The July CPI rose by 0.5 percent, below the range of forecasters' predictions of an increase of between 0.7 percent and 0.9 percent. The housing index rose by 1.1 percent, and since the beginning of the year it has risen by 3.2 percent. Inflation in the last twelve months was 1.8 percent, within the target range for the second consecutive month; adjusting for the effects of changes in indirect taxes and surcharges, inflation was 1.6 percent.
Inflation and interest rate forecasts: In the last month inflation expectations derived from the capital market and those of the private forecasters declined, and average inflation expectations for the next twelve months, about 2.8 percent, moved into the target range. The background to the decline in expected inflation included the increase in the Bank of Israel interest rate for August and the lower than expected July CPI. Inflation measured over the previous twelve months is expected to remain around the midpoint of the target inflation range for the next few months. The expected Bank of Israel interest rate one year forward, calculated from the capital market is 2.6 percent, and the forecasters, on average, expect it to be 2.8 percent. None of the forecasts referred to by the Bank of Israel predicted an increase in the interest rate for September.
Real economic activity: National Accounts data published this month indicate that the expansion of economic activity accelerated in the second quarter compared with the rate in the first quarter. GDP grew at annual rate of 4.7 percent in the second quarter, and business sector product by 6 percent. Contributing to this growth were the high rates of increase in exports and private consumption15.8 percent and 8.7 percent respectively. Fixed investment showed signs of recovery for the first time since the outbreak of the crisis. Nonresidential gross fixed capital formation increased by 7.1 percent, and residential investment by 17.1 percent, annual rates. The composite state-of-the-economy index for July rose by 0.2 percent, with significant upward revisions to the indices for the previous three months due to updated data on exports. Data on government tax revenues also indicate increased economic activity.
The Research Department staff forecast is that inflation in the next twelve months will be 2.5 percent, with a gradual increase in the interest rate during that time to about 3 percent. The current macroeconomic forecast of the Research Department of 3.7 percent GDP growth in 2010 is consistent with an expected slowdown in the rate of growth in the third and fourth quarters of the year.
The labor market and wages: The most recent labor market data show a continuation of the trend of expansion: the number of employees increased at a steady pace, and in May was 3.5 percent higher than in May 2009; claims for unemployment benefits fell by 2 percent in July relative to June; demand for labor increasedthe Central Bureau of Statistics survey for July showed a 3 percent rise relative to June in the number of vacancies; and nominal and real wages remained steady in May.
Budget data: From the beginning of 2010 until July the domestic deficit was NIS 9 billion, compared with NIS 15.7 billion in the equivalent period in 2009. On the basis of the current data, the deficit in 2010, excluding credit, is expected to be 4 percent of GDP, or even slightly lower.
The foreign exchange market: Since the previous monetary policy discussion held on July 27 until August 20, the shekel appreciated by 1.4 percent against the dollar, and by 2.8 percent against the euro. In terms of the nominal effective exchange rate, the shekel strengthened by about 1.7 percent.
The capital and money markets: Between the monetary policy discussions of July 27 and August 20, the Tel Aviv 25 index and the Tel Aviv 100 rose by 4.0 percent and 3.0 percent respectively, in contrast with declines or no change in most of the leading share price indices around the world. Both nominal and index-linked yields on Israel government medium and long term bonds declined this month , while short-term yields increased as a result of the increase in the Bank of Israel interest rate last month. The yield gap between Israeli and US nominal10-year government bonds widened slightly this month to about 160 basis points (b.p.), as a result of sharper declines in yields in the US than in Israel. The positive trend in corporate bond issues continued, along with continued investment in mutual funds specializing in corporate bonds. The Tel-Bond 20 index rose by 1 percent over the period, and the Tel-Bond 40 index by 1.5 percent. Israel's sovereign risk premium as measured by the five-year CDS spread increased slightly this month to about 122 b.p.
The money supply: The M1 monetary aggregate (cash held by the public and demand deposits) increased by 3 percent in July (including a substantial seasonal component), following its 1 percent decrease in June; in the last twelve months it increased by 9.5 percent. The M2 aggregate (M1 plus unindexed deposits of up to one year) increased slightly, by 0.2 percent, in July, following its 0.1 percent decline in June; in the last twelve months it increased by 3.3 percent.
The credit market: Total outstanding business sector credit increased in June by 1.1% to NIS 743 billion, after remaining unchanged in May. Bank credit accounted for NIS 393 billion, an increase of 1 percent from its May level. Outstanding nonbank credit (corporate bonds and nonbank loans) increased in June by 0.9% to NIS 220 billion. Credit to households grew by 0.7 percent, to NIS 324 billion. The volume of new mortgages was 10 percent lower in July than in June, but is still significantly above the average level in 2009. The rates of interest on fixed- and floating-interest indexed mortgages continued to fall, while interest rates on unindexed floating-rate mortgages remained steady in the last few months.
The housing market: The upward trend in house prices, as measured by the Central Bureau of Statistics survey of house prices (which is not included in the CPI) continued, and in May they increased by 2.2 percent, continuing the increase evident in the last seventeen months. According to the survey, house prices have risen by 21.9 percent in the last twelve months.
The global economy: Data from the US, China, France, Italy, the UK, Japan and elsewhere indicate that the probability of a slowdown in the global rate of growth increased significantly this month. Domestic private consumption, which usually constitutes a major engine for growth, did not recover in any of the major economies. In those countries which showed high rates of growth, these derived from temporary factors (fiscal stimuli and rebuilding of inventories) or exports. The general assessment is that one of the major aspects delaying the recovery in private consumption is the lack of employment security, as labor markets have not recovered yet and unemployment rates are still high. Due to the lack of certainty regarding the economic situation, companies are hesitant to invest and hire labor, despite the high profits they reported in the second quarter and the large cash holdings of many of them. Inflation in the major economies does not pose a threat for the foreseeable future, which enables central banks to keep interest rates at low levels, thereby supporting economic activity, so that interest rates are not expected to increase in the near future in the leading economies.
 
The main factors behind the decision
The decision to hold the interest rate for September at 1.75 percent is consistent with the gradual process of returning the interest rate to a more 'normal' level, intended to position inflation firmly within the target range, and to support the further recovery of economic activity, while maintaining financial stability. The pace of interest rate increases is not constant, but is set in accordance with the inflation environment, growth in Israel and globally, the monetary policies of the leading central banks, and developments in the exchange rates of the shekel. At the current level of the interest rate, monetary policy continues to be expansionary.
Ÿ Inflation in the last twelve months was 1.8 percent, below the midpoint of the target inflation range, despite the rapid rise of 5.6 percent in the housing index in that period. Inflation expectations calculated from the capital market for one year ahead and those of the private forecasters declined to below the upper limit of the target inflation range.
Ÿ Most indicators of real economic activity published this month point to continued expansion. Nevertheless, uncertainty persists regarding the rate of growth in Israel. This is due mainly to the high degree of uncertainty prevailing in the global economy, reflected in downward adjustments of growth rate forecasts by analysts and international organizations.
Ÿ Interest rates of the central banks of the major advanced economies are at very low levels, and in light of recent weak data are expected to remain so for an extended period. Nevertheless central banks in several countries that are already growing relatively rapidly continued with the process of increasing their interest rates last month too, and are expected to continue to do so in the near future.
The Bank of Israel will continue to monitor Israeli and worldwide economic and financial developments, and will use the instruments 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 housing market, and especially on house prices.
The minutes of the discussions prior to the above interest rate decision will be published on September 6, 2010.
The decision regarding the interest rate for October 2010 will be published at 17:30 on Monday, September 27, 2010.