Report (Preliminary Translation)

Monetary and macroprudential policy: During the second half of 2014, the Bank of Israel's Monetary Committee continued to reduce the interest rate: It reduced the interest rate for August and for September by 0.25 percentage points, to 0.25 percent. These reductions, especially the second one, were unexpected, taking the market by surprise. Since the interest tool is nearly exhausted, the Committee examined other tools during the surveyed period. In addition, the Bank of Israel continued its foreign currency purchases, which totaled about $1.76 billion during the surveyed period; of which about $1.46 billion was part of the program to offset the effects of natural gas production on the foreign exchange rate.  The members of the Committee believe that the main financial risk stems from credit to the housing sector, which is mitigated by the steps taken by the Supervisor of Banks in recent years. With respect to the first half of 2015, the interest rates for January and February were left unchanged.
Inflation and inflation expectations: The Consumer Price Index (CPI) decreased by 0.2 percent in the twelve months ended in December, and was thus significantly lower than the lower bound of the target range (1.0 percent). The low rate of inflation recorded in the surveyed period is primarily the result of reduced prices for tradable goods, which were affected by the continuing appreciation of the exchange rate during the first half and global price reductions; these include reduction in global commodities prices, especially the significant and surprising reduction in oil prices. It is also the result of a lower rate of increase in the prices of non-tradable goods, due to moderate domestic demand as well as structural changes, such as in the communications market, the effect of which continues. Expectations of inflation for the coming year, from various sources, continued to decrease, and were at the lower bound of the target range at the end of the period.  Some of the factors moderating inflation expectations are temporary, and are not expected to affect future inflation rates. The long-term inflation expectations are at the center of the target range.
Domestic real economic activity: In the second and third quarters, moderate growth continued and was near zero in the third quarter, as a result of Operation Protective Edge. Private consumption continued to support the continued GDP growth, but exports and fixed asset formations declined. As to the labor market, during the third quarter, there was a slight increase in unemployment as compared to the levels seen in previous quarters, but updated fourth quarter data suggested significant improvement, as well as an increase in the number of employees and a moderate growth in  real wages. Other indicators of the state of the economy paint a positive picture and reflect a return to the moderate growth seen prior to Operation Protective Edge.
The exchange rate: During the surveyed period, there was a turnaround in the shekel-dollar exchange rate (a 15 percent depreciation), as well as in the shekel-euro exchange rate (a 4.5 percent depreciation); the calculation compares December's average to July's average. The depreciation stems mainly from the strengthening of the dollar worldwide, a development which is attributed to the US economy's recovery. It also stems from two interest rate reductions and the continued foreign currency purchases by the Bank of Israel.
‎‎‎‎‎‎The global environment:‎‎‎‎‎‎ The global economy continues to grow at a moderate rate, with increasing variance among countries. As to advanced economies, the US economy is recovering but Japan's is in a recession and Europe is on the verge of one. As to developing countries, the actual growth rates, as well as forecast ones, are lower than in the past. In some countries – such as China – this development is due to structural changes, while in others – such as in Russia – it is due to the sharp and unexpected plunge in oil prices. Monetary policies remain highly accommodative and interest rates set by central banks in several countries were even negative, due to low inflation expectations and negative inflation rates in many countries. The US Federal Reserve has indeed put an end to its quantitative easing in October, but the markets expect the interest rate to increase only during the second half of 2015. The European Central Bank (ECB) continued to reduce the interest rate on the excess reserves of the commercial banks – and in October also began to purchase asset-backed securities – while additional European countries continued to reduce their interest rates. Japan decided to expand its quantitative easing.
The housing market: The 12-month rate of increase (through September and October) in home prices moderated but remained high, and currently stands at 5.8 percent; since the end of 2012, home prices have increased by an annual rate of between 5 and 10 percent. Home prices declined in some of the recent months, probably as a result of the wait for the "Zero VAT" law. In August to October, home prices rose, along with new mortgage volumes.
The financial markets: Israel's main stock market indices (Tel Aviv 25 and Tel Aviv 100) increased moderately during the surveyed period.The economy’s level of risk, as measured by the CDS premium on five-year external debt, continued its downward trend in the past few years – except during the months of Operation Protective Edge (July and August), during which the level of risk, as reflected in the said instruments, increased moderately. Total credit to the nonfinancial business sector (net of indexation and foreign exchange effects) increased slightly during the second and third quarter. Yield spreads on corporate bonds increased toward the end of the surveyed period, but are still low. Total credit to households continued to increase during the surveyed period at a growth rate similar to the one seen in the past two years, with housing credit moderating slightly and increase in the growth rate of non-housing credit. 
Fiscal policy: The government’s domestic deficit for the surveyed period was similar to the seasonal path, which is consistent with the deficit target.  The expenses were similar to the path despite the defense budget supplement for the costs of Operation Protective Edge, due to a parallel reduction in civil expenses. The annual deficit for 2014 reached 2.8 percent of the GDP. Since the 2015 state budget was not approved, after the government's dissolution, its maximum monthly expenditures will be 1/12 of the 2014 budget.
The forecast provided by the Research Department at the end of the surveyed period[1]: According to the forecast developed by the Research Department at the end of December 2014, inflation during the next four quarters is expected to be 1.1 percent – which is in the lower part of the target range. The low forecast is the result of a one-time reduction of electricity and water tariffs in January; net of this effect, the expected inflation is 1.5 percent. GDP is estimated to grow by 2.5 percent in 2014. An improvement in the growth rate is expected in 2015, to 3.2 percent, inter alia as a result of improved exports due to the depreciation and the tourism sector's recovery from Operation Protective Edge; this forecast is slightly higher than the one presented to the Committee during the surveyed period. Accordingly, the Research Department expects that the interest rate will remain at 0.25 percent in 2015. Interest rates are expected to start increasing in 2016.

[1] The section regarding the monetary policy includes a discussion of the developments of the forecasts available to the Monetary Committee during the surveyed period.