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 we announced, the Committee decided to keep the interest rate unchanged at 0.25 percent. I am happy to meet with you here again to explain the main considerations that led to the Committee’s decision.
The Committee discussed several main developments that have occurred in recent months, and how they could affect monetary policy going forward. In recent months, the Consumer Price Index increased at a slightly higher than expected pace, strengthening the assessment that inflation is stabilizing above the lower bound of the target range; data on activity indicate that it is robust and the economy is in a full employment environment; and market volatility decreased, after the sharp declines at the end of 2018 were largely corrected. Yet, in contrast, major central banks abroad signaled a pause in the process of withdrawal from accommodative monetary policy; the shekel strengthened; and there is uncertainty regarding the economic steps the next government will take after the elections. At the end of the discussions, the Committee continues to assess that in the baseline scenario, 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. I will refer now to developments in the various areas and to the policy ramifications.
The inflation environment remained stable above the lower bound of the target range. In recent months, CPI data were slightly higher than expected, and except for December, in the past nine months inflation measured over the preceding 12 months has been 1.2 percent or higher. As we showed last week in the Bank of Israel Annual Report, the connection between the various core indices and actual inflation strengthened in recent months, so that the impact of the volatile and one-off factors on inflation is smaller than in the past. The important question, of course, is whether this picture of the inflation environment will persist, or to what extent is a scenario in which inflation falls below the lower bound still plausible? The expectations and forecasts from the various sources indicate that in the coming year inflation is expected to hover slightly above the lower bound of the target range, while after that it is expected to move toward the midpoint of the target. This is indicated in the Research Department’s staff forecast, as well as in inflation expectations derived from the capital market. Various analyses support the assessment that the solid wage increases in the economy in recent years are expected to support the continued rise of the inflation rate. In contrast, there is uncertainty regarding the government’s future policy and its impact on inflation. Since a main risk to a continued increase in inflation is the possibility of continued appreciation of the shekel, a gradual and cautious path of increasing the interest rate is consistent with a continued moderate increase in inflation toward the midpoint of the target.
Fourth-quarter National Accounts data and recent months’ indicators of activity support the assessment that the economy continues to grow at around its potential rate, while the slowdown in the middle of 2018 was transitory. In particular, private consumption recovered, and indicates a high level of demand in the economy, and concern over anomalous fluctuations in the financial markets negatively impacting real activity has dissipated for now. First and second quarter data are expected to be “noisy” as increased imports of vehicles in the first quarter will apparently impact positively on investment, private consumption, and GDP data, while this impact is expected to be offset in the second quarter, and it will be necessary to be aware of this when analyzing developments and setting policy. Labor market data continue to convey a picture of a tight labor market: the employment rate is high, the unemployment rate is low, and wages continue to increase at a high rate, led by the business sector. However, several indicators point to the possibility that the labor market strength has reached its peak—some easing is apparent in the labor shortage constraint reported by employers in several industries; the job vacancy rate is still at an elevated level but is declining moderately. We will have to continue to monitor developments in order to know if the labor market picture is beginning to change. The Bank of Israel has indicated that fiscal developments of recent months heighten the need to adopt measures that will return the fiscal aggregates to a path consistent with the targets the government set for itself in this area. However, there is uncertainty about the manner and the pace in which the new government will operate in this regard, and about the ramifications that it will have on the development of real activity in the short and medium terms. In the housing market, home prices declined by 0.7 percent in the past year. There was an increase in the number of transactions by all buyer types and primarily among first home buyers, with a continued increase in volume of mortgages, the interest rate on which remained stable in recent months.
Notwithstanding the recovery in financial markets, economic activity worldwide continues to moderate, and the forecasts regarding growth in major economies and in world trade continue to be revised downward. The growth rate of world trade, a variable that historically has had a notable impact on Israeli exports, declined sharply in recent months. A possible deterioration in the trade war is a risk that could adversely impact world trade. The uncertainty regarding the timing and manner of how Brexit will occur is also weighing on global economic sentiment. Major central banks signaled that they intend to halt the process of withdrawal from accommodative policy, against the background of the deterioration in activity and in inflation. This supported a marked recovery of financial markets since the beginning of the year, though at the same time it heightened the possible impact of the renewal of the global economy’s normalization process. In addition, to the extent that interest rate increases in the US are in fact suspended, the maneuvering room for increasing the interest rate in Israel without narrowing the interest rate gap that opened in recent years will decrease to some extent. I note that monetary policy is in fact very accommodative in terms of how it is reflected in the short-term real interest rate, but the real interest rate for longer terms is closer to that of the US, where the federal funds rate is relatively high, than to Europe, where the interest rate is very low.
The depreciation at the end of 2018 was halted, and from the beginning of 2019 there has been an appreciation of approximately 4.5 percent in nominal effective exchange rate terms. As I noted, appreciation may delay the continued increase in inflation toward the midpoint of the target, and thus could impact on the path of monetary policy as well. In recent months, the Bank of Israel almost did not intervene at all in the foreign exchange market, though should there be anomalous fluctuations that are not in line with fundamental economic conditions, the foreign exchange market intervention tool remains available to the Bank of Israel.
The Research Department’s updated macroeconomic forecast presents a slightly more moderate path of activity, inflation, and the interest rate, compared with the previous forecast. The Department assesses that in 2019, GDP will grow by 3.2 percent, a slightly lower pace than projected in the previous forecast, and in 2020 GDP is expected to grow by 3.5 percent. The inflation rate is expected to be 1.5 percent in 2019, and is expected to be 1.6 percent in 2020. Regarding the interest rate path in the forecast, I emphasize that it is not a forecast by the Monetary Committee itself, but by the Department’s economists, who assess that in 2019 the interest rate will be increased once, subject to the growth and inflation forecasts materializing.
When setting the policy, the Monetary Committee takes a wide range of considerations into account. As I noted, at this stage there is uncertainty about several main factors that will impact on the policy in the near term—the development of the exchange rate, the global economy, and in particular monetary policy abroad, the development of the real economy, the policy that will be adopted by the new government, and others. At this time, according to the Monetary Committee’s assessment, the current level of the interest rate is in line with the state of the economy, and with the need to continue supporting the increase in inflation toward the midpoint of the target. To the extent that the baseline scenario, of continued growth at a solid pace and a moderate increase in inflation, materializes, it will be consistent with a gradual and cautious increase of the interest rate. To the extent needed, the Committee will be able to continue to maintain accommodative monetary policy for a more extended period of time, in a manner consistent with achieving the policy goals.
Thank you, and I wish you a happy Passover.