To Presentation (in Hebrew)
To October 2015 interest rate
Hello all.
Today the Monetary Committee decided to keep the interest rate at its low level, 0.1 percent, of previous months. In my remarks today I will review the main considerations for that decision, while focusing on the main changes in the economic environment in recent months.
Since we met at the previous press briefing in June, the picture of state of the economy has changed. The picture we saw at the end of June was of a return of inflation to within the path consistent with achieving the inflation target, and a stabilization of moderate growth as reflected in first quarter data. We noted then that the economic world is one of unexpected shocks, and the Research Department’s staff forecast, which was presented to the Monetary Committee and the general public, noted several specific risks that were likely to negatively impact the materialization of the projections. Some of the risks noted then materialized relatively rapidly—there was further weakness in the global economy, seen in financial markets and in world trade growth, which negatively affects Israel’s exports, and oil prices began to again decline, which although in and of itself is positive news for the Israeli economy, delays the return of inflation to within the target range. Likewise, since then, second quarter growth data were published, which surprised in their weakness, and changes in tax policy were made.
During the course of the third quarter, and to a stronger extent in the past month, there was a further decline in the short-term inflation environment. Inflation as measured over the preceding 12 months remains negative (-0.4 percent), and was markedly impacted by global energy and commodity prices. Thus, for example, the CPI excluding energy, food, fruit and vegetables increased by 0.8 percent. However, monetary policy is forward looking—the current level of the interest rate, representing a very accommodative monetary policy, supports the return of inflation to within the target range, although processes with a one-off nature—chief among them the decline in fuel and electricity prices, and the VAT reduction—will delay the process. Financial markets also view these declines as transitory ones, and this is reflected in forward inflation expectations for medium and long terms remaining entrenched within the target range.
The Monetary Committee is of the opinion that the rate of growth moderated somewhat. National Accounts data indicated, as noted, a sharp decline in the rate of growth in the second quarter, led by exports and investment, and this picture became even clearer with the publication of the second estimate of the data. However, the National Accounts data were also affected to a considerable extent by one time factors—the strike at Israel Chemicals Ltd. had a material effect on goods exports, and in the first two quarters of 2015 there was a correction in vehicle imports, which had risen sharply at the end of 2014. Net of these two factors, there is a slight decline in the growth rate apparent during 2015, which is in line with the decline in world trade as well. Foreign trade data support the assessment that there is some improvement in the third quarter. Likewise, unemployment is low, the labor force participation rate and the employment rate are relatively high, and wages increased by a real rate of around 3 percent over the past year. Nonetheless, over time, the virtual standstills in exports, the economy’s growth and productivity driver, and in investment, are worrying. The low interest rate and Bank of Israel activity in the foreign currency market support exports, but steps by the government to encourage exports and for extended support of increased productivity are required, in order to bring about a change in the trend of exports’ growth rate.
The effective exchange rate is at a level similar to where it was at the time of the previous briefing, and based on various assessments it is somewhat overvalued relative to estimates of the equilibrium exchange rate. During the course of the third quarter as well, the Bank of Israel intervened in the foreign exchange market, buying $2.2 billion. This activity is another tool operated by the Monetary Committee and which will continue to help achieve the policy targets.
The picture of the global economy facing us today is weaker than what we saw three months ago. There was considerable volatility in global financial markets, with declines in price levels in some of the markets. It should be remembered that the source of the volatility was China’s economy, and the change occurring there is expected to have a negative impact on the global economy in the short term. The OECD revised its growth forecast downward, and the assessments are that the next revisions that will be published by other international institutions will be downward, both in terms of growth and in terms of world trade. Against this background, the accommodative monetary policy worldwide continues, and the US Federal Reserve decided to defer for now an initial federal funds rate increase. The expected path of the federal funds rate is somewhat lower today than what we faced three months ago, but most FOMC members still expect that the process of increasing the rate will begin this year. This process, to the extent that it will reflect a sustainable recovery of the US economy, will be positive news for the global economy in general, and the Israeli economy in particular. Incidentally, since the previous briefing, the risk of a deterioration of the crisis in Greece has declined.
Today, the Research Department published its updated forecast. It should be remembered that this is a contingent forecast based on assumptions regarding exogenous variables. The new forecast was negatively impacted by second quarter data, which surprised to the downside, and this was one of the factors in projected 2015 GDP growth being reduced from 3 percent in the previous forecast, to 2.6 percent in the current one. The forecast for 2016 was also reduced, influenced mainly by the global slowdown, from 3.7 percent to 3.3 percent. The return of inflation to within the target range is expected, according to the revised forecast, to be further delayed by several relatively significant one-off factors—an additional decline in fuel prices, the reduction of VAT and other taxes, the reduction in electricity prices, and more, so that the inflation rate is only expected to return to within the target range at the end of 2016. As a result of these factors, the Research Department forecasts that the Monetary Committee will keep the interest rate at its low level for a longer period of time.
The interest rate policy supports the achieving of the Bank of Israel’s objectives, and also takes into account financial stability in general, and the housing market in particular. The rate of mortgages being taken out remains elevated, and the Bank of Israel continues to closely monitor the development of risks in this area. Although recently there was some acceleration in the rate of price increases, in recent months the increase in construction volume has continued, and this is an important development that will be able to contribute to reducing pressure on home prices. It is important that the government continue efforts to increase the stock of land available for construction and the supply of housing available for residences.
In conclusion, we presented the main developments under which monetary policy was conducted during the third quarter. The short-term inflation environment declined during the period, but this decline primarily reflects one-off factors, which are not expected to impact inflation for an extensive period of time, and which do not reflect weakness in domestic demand. The labor market still continues to show strength. However, some slowdown is becoming apparent in economic activity, against the background of the slowdown in the global economy, and in the US the liftoff of the federal funds rate was pushed off for now. In light of all these, the Monetary Committee was of the opinion that the very low level of the interest rate, 0.1 percent, provides, as of now, the support required to achieve the policy objectives: price stability, and support of growth and employment. With that, the uncertainty about the future has not declined. The risks to global growth remain high and are seen in an absence of growth in investments and in exports. These are a source of concern regarding the economy’s future growth capacity. The Bank of Israel will continue to closely follow developments in the global and Israeli economies, and the Monetary Committee will be able to operate all the policy tools available to it, at any time, should there be a need.
Chag Sameach – Happy holiday!