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Background conditions


Inflation data: The Consumer Price Index (CPI) for November declined by 0.5 percent. Forecasts projected a decline of 0.1 percent, on average. This is the third consecutive month in which the CPI has surprised to the downside. The development of actual prices indicates continued moderation of the inflation environment. The rate of inflation over the previous twelve months was 1.4 percent, compared with a figure of 1.8 percent last month.




Inflation and interest rate forecasts: Forecasts of the inflation rate over the next twelve months based on the average of forecasters' inflation predictions, and on inflation expectations based on over-the-counter CPI futures contracts offered by banks, declined slightly during the month, and are currently about 1.8 percent. Expectations calculated from the capital markets (break-even inflation) declined as well this month, to a seasonally adjusted rate of 1.7 percent, or 2.2 percent without seasonal adjustment. Inflation expectations for two years and longer were stable and remained at around 2.3–2.6 percent. Expectations for the Bank of Israel interest rate one year from now derived from the Telbor (Tel Aviv Inter-Bank Offered Rate) market as well as expectations based on the average projection of forecasters are for an interest rate of 1.8 percent. The forecasters who provide projections to the Bank of Israel predict that the Bank will reduce the interest rate by 0.25 percentage points during the first quarter.




Real economic activity: Indicators of real economic activity that became available this month point to a continuation of the slowdown in activity, and the GDP growth rate in the fourth quarter is expected to be lower than the previous quarter. The slowdown can be seen in the Composite State-of-the-Economy Index. The index increased by 0.1 percent in November, and its low rate of growth in recent months reflects a decline in manufacturing production and a slowdown in goods exports. The results of various surveys of activity also indicate continued slowdown. The source of the weakness in activity is apparently related to a slowdown in exports due to weakness in global markets, a slowdown in world trade, and the effects of Operation "Pillar of Defense". Some of the indicators pointing to a moderation in activity (primarily foreign trade data) were negatively impacted in November by Operation "Pillar of Defense", which is mostly a temporary effect. During the fighting, about 5 percent of the workforce was absent. During the operation there was a sharp decline in tourist entries into Israel, and past experience has shown that this effect will likely continue several months after the operation ended, as well. As a result of the operation, the economy lost about 0.3 percent of GDP during the fourth quarter (in quarterly terms).




The labor market: Labor force survey data which became available this month indicate that the unemployment rate in the economy increased slightly in October, to 7 percent, with a decline of 0.3 percentage points in the participation rate, to 63.8 percent. With that, if the figures for ages 25–64 are examined (that is, the age range affected less by changes in the survey's methodology earlier this year), it can be seen that there was a slight decline in the unemployment rate in October, with a decline in the rates of participation and employment. In September, the number of employee posts continued to decline in the business sector, and continued to increase in the public sector. The Business Tendency Survey indicates an expected slowdown in the increase of the number of employees in the coming 3 months. Nominal wages increased by 0.5 percent in the third quarter, compared with the previous quarter, and real wages increased by 0.4 percent, based on seasonally adjusted figures. Health tax receipts, which provide an indication of nominal wage payments, were 4.8 percent higher in October–November than in the corresponding period of the previous year, compared with a year over year increase of 5.8 percent in September–October.




The Bank of Israel Research Department staff forecast: This month, the Bank of Israel Research Department updated its macroeconomic forecast. In the Research Department's assessment, the inflation rate is expected to be 1.8 percent in 2013. The Bank of Israel interest rate, which was 2 percent when the forecast was being compiled, was expected to decline in the near term to 1.75 percent, and to then remain unchanged until at least the end of 2013. The GDP growth rate in 2012 is estimated to be 3.3 percent. The growth rate for 2013 is projected to be 3.8 percent, assuming that production of natural gas from the Tamar field begins during the second quarter of 2013, as planned, and reflects the methodology used by the Central Bureau of Statistics regarding the recording of the gas output (and replacement of fuel imports) in the National Accounts. Excluding the production of natural gas from the Tamar field, GDP is expected to increase in 2013 by 2.8 percent, compared with a projection of 3.0 percent in the previous quarter's forecast. It should be noted that gas production requires only very small inputs of labor, and that accordingly the expected development of employment and unemployment is determined largely by the growth rate of GDP excluding (rather than including) gas production.




Budget data: The deficit in domestic government activity totaled about NIS 21.2 billion in January–November, some NIS 8.7 billion greater than the seasonal path consistent with the Ministry of Finance's deficit forecast at the beginning of 2012 (3.4 percent of GDP). Based on developments to date, the deficit for the full year is projected to reach about 4–4.2 percent of GDP, assuming that government expenditure does not surpass the original amount in the budget. The accumulated deviation from the seasonal path consistent with the Ministry of Finance's original projection results from revenues some NIS 7.2 billion below the path, and expenditure which is about NIS 1.5 billion above the path.




The foreign exchange market: From the previous monetary policy discussion held  on November 25, 2012, through December 21, 2012, the shekel strengthened against the dollar by about 3 percent, an appreciation which was especially notable compared with that of most major currencies against the dollar. The shekel's strength occurred primarily against the background of a renewed trend of shekel purchases by nonresidents since the end of Operation "Pillar of Defense". The shekel appreciated by 1.5 percent against the euro, while most major currencies weakened against the euro. In terms of the nominal effective exchange rate the shekel appreciated by about 2 percent during the period since November 25.




The capital and money markets: From the previous monetary policy discussion held on November 25, 2012, through December 21, 2012, the Tel Aviv 25 Index increased by about 0.8 percent. Yields declined by about 10 basis points on unindexed government bonds, on average, and declined by about 15 basis points on CPI-indexed government bonds. This trend of declining yields on government bonds was in contrast to the global trend, and occurred, among other things, against the background of the Ministry of Finance's notice of reduced issuance volume in the coming quarter. The yield differential between 10-year Israeli government bonds and equivalent 10-year US Treasury securities declined by 25 basis points, to 220 basis points. Makam yields also declined along most of the curve, with one-year yields declining to 1.8 percent during the period. Israel's sovereign risk premium as measured by the five-year CDS spread declined slightly during the intermeeting period to 135 basis points. The Tel-Bond 60 Index remained unchanged, but spreads in the corporate bond market declined further, encompassing all ratings and industries.




The money supply: In the twelve months ending in November, the M1 monetary aggregate (cash held by the public and demand deposits) increased by 7.1 percent, and the M2 aggregate (M1 plus unindexed deposits of up to one year) increased by 7.6 percent.




Developments in the credit markets: The outstanding debt of the business sector increased by 0.7 percent in October, from NIS 783 billion to NIS 788 billion; in the past 12 months the debt has increased by 3.5 percent. Total outstanding credit to households increased in October by 0.6 percent, to NIS 386 billion. The total volume of new mortgages granted in November was NIS 4.1 billion, compared with NIS 3.4 billion in October. The balance of housing debt was NIS 275 billion at the end of October, an increase of 7.5 percent since October 2011. Interest rates on new CPI-indexed mortgages granted in November remained essentially unchanged, and declined in the unindexed, floating-rate track following the reduction of the Bank of Israel interest rate in November. About two months ago, directives from the Supervisor of Banks went into effect, limiting the loan-to-value ratio in new housing loans, but it is still too early to estimate their effect on the housing market, as these directives exclude, until the end of the year, loans which were approved in principle before the directives came into effect.


The housing market: The housing component of the CPI (representing rents) declined by 0.2 percent in November. In the twelve months ending in November, it increased by 2.8 percent, compared with an increase of 2.2 percent in the twelve months to October. Home prices, which are published in the Central Bureau of Statistics survey of home prices but are not included in the CPI, increased in September–October by 0.5 percent, after increasing by 0.6 percent in August–September. In the twelve months ending in October, home prices increased by 3.7 percent, compared with an increase of 2.3 percent in the twelve months to September.


The number of building starts over the previous 12 months remains high (38,650 in the 12 months ending in September, compared with 40,097 in the 12 months which ended in August), and it is expected to continue to be reflected in an increased stock of homes. With that, in the third quarter there was a sharp decline in the level of building starts, and the rate of properties marketed by the Israel Land Administration has decreased significantly.


The global economy: This month, the OECD updated the 2013 growth forecast for its member nations, reducing it from 2.2 percent to 1.4 percent, and also cut its US growth forecast, from 2.6 percent to 2 percent. According to the OECD, if the US does not resolve its budget problems (the "fiscal cliff"), and Europe does not progress toward solving its debt crisis, the world economy may enter another recession. Central banks in major economies revised their growth forecasts downward. Recently, many macro data in the US and China have surprised to the upside, while data in Europe and Japan indicate that they are headed into recession. There was some relief in the European debt crisis as the transfer of aid to Greece was approved. In addition, agreement was reached on ECB supervision of major eurozone banks, allowing those banks to receive direct aid from the euro area's permanent crisis resolution fund, the European Stability Mechanism. The US Federal Reserve announced the expansion of its quantitative easing program by $45 billion per month; these funds will be used to acquire Treasury securities, and they are in addition to funds—around $40 billion per month—which the Federal Reserve allocated in September to acquire mortgage-backed securities. The Fed also announced that the asset purchase program and the near-zero federal funds rate are expected to continue as long as the unemployment rate is above 6.5 percent, and provided that the inflation forecasts for 1–2 years ahead are not above 2.5 percent. Commodity prices in general, and oil prices in particular, declined slightly this month.
The main considerations behind the decision



The decision to reduce the interest rate for January 2013 by 0.25 percentage points, to 1.75 percent, is consistent with the Bank of Israel's interest rate policy which is intended to entrench the inflation rate 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, the global economy, 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 development of actual prices, inflation expectations for the year ahead, and recent months' surprises to the downside in the CPI indicate a continued decline in the inflation environment, and apparently weakness in domestic demand as well. Inflation over the previous 12 months was below the midpoint of the target range, and inflation expectations for the year ahead are near the midpoint of the target range. Commodity prices in general, and oil prices in particular, declined slightly this month; these are expected to have an impact on domestic prices in the future.
  •  Indicators of real economic activity continue to point to weakness, and further moderation in the rate of growth is likely. In addition, the shekel's recent strength may make it more difficult for the economy to deal with the challenges it faces. This month, the Research Department updated its growth forecast for the coming year. Excluding the impact of the start of natural gas production from the new field, Tamar, growth in 2013 was revised downward to 2.8 percent, compared with 3 percent in the previous forecast. The forecast including natural gas production is for 3.8 percent growth. It should be noted that gas production requires only very small inputs of labor, and that accordingly, the expected development of employment and unemployment is determined largely by the growth rate of GDP excluding (rather than including) gas production.
  •  The level of economic risk from around the world remains high, and with it the concerns over negative effects on the local economy. Growth forecasts of major economies around the world were reduced by the central banks of those countries and by the OECD. There is still uncertainty regarding the "fiscal cliff" problem in the US and the debt crisis in Europe. Macro data in Europe, including the core countries there, indicate entry into a recession; in contrast, US and Chinese macro data surprised to the upside.
  •  The US Federal Reserve bank announced an additional quantitative easing program, and said that the asset purchase plan and the near-zero federal funds rates will continue as long as the unemployment rate is above 6.5 percent and inflation 1–2 years ahead is projected to be below 2.5 percent. Several central banks reduced interest rates this month. In addition, markets are not pricing in an interest rate increase this year by any of the central banks of the large advanced economies.
  •    Home prices continued to increase in September–October. However, it is too early to assess the impact on home prices of the LTV ratio limitations which were imposed by the Supervisor of Banks and went into effect at the beginning of November.

Against the background of the need to provide additional support for economic activity and the absence of inflationary pressures at this time, the Monetary Committee decided to reduce the interest rate by 0.25 percentage points.


The Bank of Israel will continue to monitor developments in the Israeli and global economies and in financial markets, particularly in light of the continuing high level of uncertainty in the global economy. 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, and in this regard will keep a close watch on developments in the asset markets, including the housing market.


The minutes of the discussions prior to the above interest rate decision will be published on January 7, 2013.

The decision regarding the interest rate for February 2013 will be published at 17:30 on Monday, January 28, 2013.