Good afternoon.  

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 will say at the outset that the decision was not easy, and was not unanimous. When the minutes of the meeting are published in two weeks, you will be able to see the considerations in favor of reducing the interest rate at this time. The current and future economic pictures presented to the Committee during the course of the discussions are complex. We attempted to assess the meaning of the decline in inflation we have seen in recent months, and the extent to which it is expected to persist. We analyzed the developments in the real economy, and the economy’s ability to continue to grow at its potential rate despite the uncertainty in Israel and the winds blowing in from the global economy: we examined to what extent the global slowdown, the trade war, and the turnaround in monetary policy in major economies could require a policy response in Israel as well; and clearly we dealt with developments in the exchange rate, its impact on the tradables sector and of course on inflation, and the policy required. I will now expand on the developments and how the Committee views them, in each of the areas.

In recent months, there has been a decline in the inflation environment, after the inflation rate declined within two months from 1.5 percent to 0.5 percent (and subsequently rose to 0.6 percent). Most of the decline in inflation was a result of relatively volatile factors—the decline in fruit and vegetable prices and energy prices, though it is likely that the cumulative appreciation in the shekel, after the depreciation in 2018, impacted on the inflation rate as well. Inflation net of the effect of energy and fruit and vegetables has been far more stable: after the prolonged moderate increase in this index, from the beginning of the year it has fluctuated in a narrow range near 1 percent, and the components included in it did not reflect the decline we saw in headline inflation in recent months. In the coming months, a further decline in year over year inflation is expected, but 1-year inflation expectations from most sources are for inflation to converge to around the lower bound of the target range, and then continue to increase moderately. Several forces could moderate inflation going forward: it is plausible that the appreciation that occurred from the beginning of the year, particularly if it persists, will impact on inflation—though it is difficult to assess the pass-through from the exchange rate to prices and it changes over time—and to the extent that the global slowdown becomes more severe, it could impact on the inflation environment. The increase in wages in the economy is expected to continue to support an increase in the inflation rate, even if the pace of wage increases moderated recently. If, after a new government is established, it will decide to raise indirect taxes as part of its dealing with the budget challenge, it will lead to a one-off increase in prices, but it should not have an impact on the base inflation rate.

Indicators of real activity point to the economy continuing to grow at around its potential rate, and so far it has been relatively resilient to the global slowdown and the political uncertainty in Israel. In particular, all the labor market data continue to indicate a tight labor market, and while there is some moderation in part of the data, such as the pace of wage increases or the job vacancy rate, the moderation is from a relatively high level. Export performance is satisfactory, especially in view of the absolute standstill in world trade and the shekel appreciation. The process of structural change in exports, as part of which the share of services exports increased and the share of goods exports decreased, made exports less vulnerable to such developments. With that, there has been some increase in the share of exporters reporting an erosion in export profitability. Moreover, should the global slowdown extend to technology industries it will obviously have an impact on Israeli high tech as well. The lack of political clarity has also so far not adversely impacted real activity or financial markets in Israel. Growth in the principal industries continues, and in the construction industry, in which government policy has a marked impact, no slowdown is apparent. With that, the delay in forming the government pushes off the handling of the economy’s long-term problems, which the Bank of Israel pointed to in our special report on productivity; and it pushes off taking the urgent steps required to return the deficit and the debt to GDP ratio to a sustainable path. The uncertainty regarding the intensity and the precise makeup of the steps that the government will take makes it difficult for us to assess at this stage what effect they will have on developments in the coming year.

The negative sentiment in the global economy continues, and the growth forecasts were reduced for most geographical regions. International trade stopped growing and the effects of the trade war are liable to become more severe. The uncertainty regarding Brexit has been with us for several years, but the most recent estimates published regarding the possible effect of no deal on growth in the UK and Europe are quite significant. To date, as I noted, the global slowdown has not overly affected economic activity in Israel, but this is liable to change relatively rapidly, should the slowdown reach the capital markets and the technology industry. Inflation in most economies is still below the targets guiding central banks, and some of them, particularly the Fed and the ECB, shifted monetary policy back to a path of accommodation. At this stage, it is not clear if additional accommodative steps will be taken. For the year to date, the shekel has strengthened by 9.1 percent in terms of the effective exchange rate. Part of the appreciation is the result of the relatively good state of the Israeli economy and of the Current Account surplus, but there is also an effect from the change in the relative interest rates and other financial developments. Until now, as is known, the Bank of Israel has not intervened at a significant level in the foreign exchange market. There is a window of exchange rates that we view as being consistent with price stability and economic activity, when taking into account all the factors and variables in the economy. To the extent that the exchange rate deviates markedly from the window we defined, the Bank of Israel will intervene in the market.

The Research Department presented its updated macroeconomic forecast to the Monetary Committee and published it for the public. The Research Department projects that in 2019, GDP will grow by 3.1 percent, similar to the previous forecast, while the growth forecast for 2020 was reduced to 3 percent, compared with 3.5 percent in the previous forecast, against the background of the global economic slowdown’s expected effect on exports, and the assumption that the government will take steps to reduce the deficit. The inflation rate is expected to rise gradually, reaching 1.2 percent in 2020. In view of the developments in inflation, the exchange rate, and the global economy, the Research Department assesses that the interest rate will remain unchanged or will be reduced during 2020.

At the end of the discussions today, the Committee assessed that in view of the inflation environment in Israel, the monetary policies of major central banks, the moderation in the global economy, and the continued appreciation, there will be a need to keep the interest rate at its present level for an extended period or to reduce it, in order to support a process at the end of which inflation will stabilize around the midpoint of the target range and the economy will grow at an adequate pace. Moreover, if necessary, the Committee will take additional steps in order to enhance the level of monetary accommodation. Beyond the interest rate decision, I will take this opportunity to reiterate how important it is for the government that is established to deal determinedly with the budget challenge, and to outline and implement plans that will provide a response to the long-term challenges of the Israeli economy.

Thank you, and happy New Year.​