Remarks by the Governor of the Bank of Israel at the press briefing on monetary policy held today at the Bank of Israel
Yesterday and today, the Monetary Committee held discussions at the Bank of Israel in order to decide on the interest rate. At their conclusion, as you know, the Committee decided to keep the interest rate unchanged at 0.25 percent. In prefacing my remarks, I note that since entering the post exactly two weeks ago, I have already held several discussions with the Monetary Committee as well as with economists from the various departments at the Bank. I was impressed by the depth of the discussions in the Committee, and by the quality of the material presented by the Bank’s economists, as well as by the orderly procedure of the discussions ahead of policy decisions. I am happy to meet with you here and to explain to the general public the considerations that led to the current decision, as well as the Committee’s appraisals regarding future economic developments and policy.
As you know, in the previous interest rate decision, the Committee raised the interest rate to 0.25 percent, following more than three and a half years during which it had remained constant at 0.1 percent. It also assessed that the rising path of the interest rate in the future will be gradual and cautious. Although only six weeks have passed since then, quite a few significant economic events occurred during that time—financial markets worldwide, including in Israel, experienced considerable volatility, and prices declined, at times sharply; the assessments for continued growth of real activity in Israel and worldwide were reduced slightly; and Knesset elections were brought forward, which somewhat increased the economic uncertainty. In the Committee’s discussions, we attempted to assess the expected impacts of all these processes on inflation and growth, and as a result, on future monetary policy. As noted in the Committee’s press release on the interest rate decision, the Monetary Committee assesses that the rising path of the interest rate in the future will be gradual and cautious, in a manner that supports a process at the end of which inflation will stabilize around the midpoint of the target range, and that supports economic activity. With that, various factors could impact on the policy, as I will explain later in detail.
The inflation environment stabilized in recent months near the lower bound of the target. Most factors that have supported inflation to date—wage increases, the economy being at full employment, and recent months’ shekel depreciation, to the extent it persists—are expected to continue acting toward a further increase in inflation. The planned increases in the prices of several supervised goods and services are expected to have a relatively slight impact on inflation. Energy prices declined sharply since the beginning of October after a prolonged rise beforehand, and to the extent that the current price level will persist, it may have a moderating impact on inflation worldwide and in Israel in the short term. Based on inflation expectations and forecasts from the various sources, the inflation rate is expected to remain near, or slightly above, the lower bound of the target in the coming year, and afterward to rise toward the midpoint of the target. If these forecasts are realized, they will be consistent with gradual contraction of the monetary policy accommodation.
The growth rate slowed in the second and third quarters of 2018, and with indicators of fourth quarter activity being mixed, we can ask what the factors in the slowing were, and if it is expected to continue. The analysis carried out at the Bank of Israel indicates that the slowing reflected essentially one-off factors, and apparently the supply constraint is leading to the economy converging to its potential growth rate. This assessment is supported, first and foremost, by the tight labor market—the low unemployment rate, the high employment rate, the continued increase in real wages, and the high job vacancy rate. The decline in the current account surplus also supports the assessment that the slowing derives from a supply constraint, which leads to the increase in demand being met by an increase in imports. In the past year, there has been a decline in investment in imported machinery and equipment, which seems to be inconsistent with the assumption that the supply constraint is what slowed activity. However, an analysis of the components indicates that the decline is the outcome of the cessation of a large one-off investment in the chip industry, while investment in other industries remains at its level of recent years. The main uncertainty regarding the source of the slowing in the economy derives from current private consumption, which drove the growth of recent years, and recently slowed to below the long-term pace. Consumption has been supported in recent years by prolonged growth of labor income, but also by the wealth effect resulting from the increase in the value of the public’s asset portfolio. Looking forward, it is difficult to assess whether the financial market fluctuations will continue, and whether they will have been significant enough to have a negative wealth effect on private consumption. All in all, if the baseline scenario materializes, and there is not a marked deterioration in the rate of growth, the Committee assesses that the state of the economy will be consistent with, as noted, a gradual and cautious path of increase in the interest rate. To the extent that such deterioration does occur, so long as inflation is far from the upper bound of the target range, it will be possible to support activity by a slower path of contraction of the monetary accommodation.
In the housing market, the number of transactions appears to be stabilizing, with a moderate increase in mortgage volume. Price declines moderated, and so have building starts in the past year. In order to support a process of reducing prices, , there is a need to increase the pace of building starts, so as to provide a response to housing demand.
In recent weeks there was a deterioration in the global economic picture; while US growth remains solid for now, in other regions activity is weakening. After several years of continued relative increase in asset prices in major financial markets, in recent weeks there were relatively sharp price decreases, declines in government bond yields, and increases in risk indices. Political risks as well continue to weigh on growth—concerns of a trade war are again on the public agenda and its impact is apparently already beginning to be felt, the uncertainty about Brexit continues, and risks remain in Europe as well. Except for the US, inflation in most regions remains moderate, and monetary contraction worldwide is expected to be halted to some extent; although the federal funds rate rose in the US, as expected, and rates rose in several other economies as well, financial markets are currently pricing in an expected freeze of US interest rates and a deferral of the expected date for beginning interest rate increases in Europe. In emerging markets there was relative calm in recent weeks, though some of them are very sensitive to developments such as the monetary tightening in the US, the worsening of the trade war, and the fluctuations in energy prices.
Against the background of the decline in the current account surplus, and the widening interest rate gap against the US, for the past four months the shekel has been depreciating gradually, and these trends contributed to the stabilization of inflation above the lower bound of the target and to a rise in expectations. Should there be a change in trend in the exchange rate, it is liable to slow the increase of inflation to around the midpoint of the target range. Since February 2018, the Bank of Israel has not intervened in the foreign exchange market, except within the framework of the purchase program to offset the effect of natural gas production on the exchange rate, a program that was not renewed in 2019. To the extent that there will be anomalous fluctuations that are not in line with fundamental economic conditions, the foreign exchange market intervention tool is still available to the Bank of Israel.
The Bank of Israel Research Department presented its macroeconomic staff forecast to the Monetary Committee and published it today. The Department assesses that in the coming two years the economy will converge to the potential growth rate of approximately 3 percent, and benefit from temporary additional growth due to expected activity at several large companies: in 2019 GDP will grow by a rate of 3.4 percent, slightly lower than the rate estimated in the previous forecast, and growth of 3.5 percent is expected in 2020. In 2019, the inflation rate is expected to be 1.3 percent, and in 2020 it is expected to be 1.8 percent—near the midpoint of the target. As for the interest rate path in the forecast, I would like to emphasize, that this is not a forecast by the Monetary Committee itself, and it has happened in the past that the interest rate changed at a different time than what was estimated in the published forecast. After the increase in the interest rate in November, the Research Department assesses that there will be a moderate rise in the interest rate in 2019, and the pace of increase will accelerate somewhat, only in parallel with an additional increase in the inflation expected in 2020. I emphasize that it is important to pay attention to the fan charts that describe the broad range of uncertainty that characterizes the forecast for the various variables. Moreover, the Research Department described the risks in the forecast, which at the current time are mostly biased to the downside.
To conclude, the policy set by the Monetary Committee will be directed so that over the long term, inflation will be entrenched around the midpoint of the target range, while throughout the process the Committee will want to verify that the monetary policy supports continued growth of economic activity at a solid pace. According to the Committee’s baseline scenario, inflation is expected to continue to rise gradually over the next two years, and real activity is expected to continue to grow in accordance with its potential rate. This scenario would be consistent with a gradual and cautious increase of the interest rate. However, there are several main risks to the baseline scenario: inflation could slow if the appreciation renews, and real activity could be adversely impacted by global economic developments in general, and global financial markets in particular. To the extent that these risks materialize, the Committee will be able to continue to conduct accommodative monetary policy for a more extended time, in a manner that will be consistent with achieving the policy goals.