Remarks by the Governor of the Bank of Israel at the press briefing on monetary policy held today at the Bank of Israel
Over the last two days, the Monetary Committee held discussions at the Bank of Israel 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. The economic picture as it was presented to the Committee was complex. Growth in major economies is expected to continue to moderate in 2020, but the risks of a marked deterioration in the global economy declined, and growth is expected to improve in 2021. Likewise, there is greater certainty regarding the future path of major central banks’ monetary policy. However, in contrast, the interim government budget will have a contractionary effect in the coming months, and there continues to be considerable uncertainty regarding budget policy after the elections, and its ramifications. The Committee attempted to assess the impact of the developments in Israel and abroad on economic activity in the near term. Regarding inflation, it is still not clear if there has been, in fact, a further decline in the inflation environment, or if the below-target inflation rate is in fact temporary and impacted by relatively volatile factors. We also discussed foreign exchange market developments and the required policy responses. I will now expand on the developments and how the Committee views them in each of the areas.
The inflation environment continues to be very low, and the most recent CPI reading surprised to the downside again. The year-over-year inflation rate has been around 0.3–0.4 percent over the past 3 months, against the background of the cumulative shekel exchange rate appreciation, the decline in fruit and vegetable prices, and some slowdown in the rate of increase in the housing component. In parallel, there was a decline as well in the inflation rate net of the effect of energy, fruit and vegetable prices, and it is only slightly higher than headline inflation, which probably points to a decline in the basic rate of inflation. In the coming months, the year on year inflation rate is expected to remain low, but as of now, the assessments are that after the June 2019 CPI reading, which was particularly low, exits the calculation, the inflation rate will return to near the lower bound of the target range. Economic growth, the tight labor market, and wage increases are expected to support the return of the inflation rate to the target range. In contrast, the lagged effect of the shekel appreciation over the past year is expected to continue to pressure the inflation rate downward in the coming months, and the enhancement of competition in the economy, a desired phenomenon in and of itself, will continue to act to reduce the inflation rate over time. As long as demand in the economy continues to be strong, it will continue to act to increase the inflation rate, even if the forces acting in the opposite direction are likely to lengthen the time it will take until the inflation rate returns to within the target range.
During the summer and fall, concerns grew about economic activity in Israel, but third quarter data indicated that the economy grew at a solid pace. Export data were weak, but they grew at a solid pace before that, and it is too early to tell if this is transitory weakness or the beginning of a change in the trend, deriving from the slowdown in world trade and from the shekel appreciation. Indicators that have recently been released show that the economy continued to grow in the fourth quarter of 2019 as well, and the most recent data indicate that services exports continue to grow rapidly. The labor market remains tight despite some weakness apparent in some of its parameters—the unemployment rate remains low, with a high level of participation and employment, and wages continue to increase though with some slowdown in the rate of increase. The job vacancy rate continues to decline moderately, and the increase in the number of employee posts halted, though this actually may be a result of a shortage of workers, which is also expressed in the renewed increase in the number of companies reporting employee recruitment as a constraint. Fiscal policy is expected to have a marked effect on activity in the coming months: in the first half of 2020, the interim budget is expected to be contractionary, and business sector entities providing services to the government are likely to be impacted by that. In addition, there is uncertainty regarding the fiscal policy that will prevail after the elections, as it is likely to be contractionary as well, should necessary steps to deal with the rising deficit be taken. As long as the political and fiscal uncertainty continues, it sharpens the need to keep monetary policy accommodative in order to support growth.
During 2019, risks increased in the global economy and bolstered the concerns of a turnaround in growth, which led at the time to a renewed process of monetary accommodation around the world. In the previous interest rate decision, we pointed to some decline in the magnitude of the risks, and in recent weeks, it appears that there was a further improvement in global sentiment. Although growth remained low in several major economies, the political risk decreased thanks to progress in the US-China trade talks and clarification of the Brexit picture after the UK elections. World trade remains notably weak. It is important to note that to date there has not been a negative impact on capital markets or in the technology industry in the US, which have a direct influence on the high tech industries in Israel. The decline in the magnitude of the risks and the continued price rises in financial markets led to a halt in the trend of monetary accommodation: after three interest rate reductions, the US Federal Reserve kept the federal funds target rate unchanged in December, and the summary of the discussions published afterward indicates clearly that Federal Reserve officials were of the opinion that at this time the current interest rate level is appropriate for continuing to support economic activity and keeping the inflation rate near the target. In Europe, as well, it appears that the ECB is content for now with the interest rate reductions that it already carried out. It is interesting to note that Sweden’s central bank raised the interest rate to zero, after it had been negative for several years, and inflation stabilized near the 2 percent target.
Since the interest rate decision at the end of November, there has been relatively significant Bank of Israel intervention in the foreign exchange market. Throughout most of 2019, the strengthening of the shekel was striking compared to other currencies, and in our assessment, the shekel strengthened beyond what would have been expected as a result of the economy’s good macroeconomic fundamentals. As a result, the exchange rate deviated from the window that is in line with continued solid economic activity and price stability. The transaction data that the Bank of Israel collects indicate that the appreciation was partly the result of short-term financial factors, which were liable to adversely impact economic activity and the return of inflation to within the target range. I emphasize that the Bank of Israel is prepared to prevent excessive appreciation of the shekel, by purchasing foreign exchange whenever necessary, and particularly to the extent that we assess that the appreciation is the result of relatively short-term financial factors. Decisions on the extent of intervention are reached in accordance with assessments regarding the development of the exchange rate and its effect on the macroeconomic variables.
The Research Department today released its updated macroeconomic forecast that was presented to the Monetary Committee. The Research Department assesses that in 2020, there will be some slowdown in the growth rate—GDP will grow by 2.9 percent, of which 0.3 percentage points is the result of the one-off effect of the start of natural gas production from the Leviathan field. This is primarily a result of the fiscal contraction, along with the slowdown in world trade. In 2021, the growth rate is expected to increase to 3.2 percent. The inflation rate is expected to rise gradually, reaching 1 percent in the fourth quarter of 2020 and 1.4 percent at the end of 2021. In view of the developments in inflation, the exchange rate, and the global economy, the Research Department’s assessment is that the interest rate will remain unchanged, but noted that there may be a need to reduce the interest rate during the coming year.
At the end of the discussions today, the Committee kept in place its assessment that in view of the inflation environment in Israel, the monetary policies of major central banks, the developments in the global economy and the risks to the domestic economy, and the development of the exchange rate, it will be necessary to keep the interest rate at its current level for a prolonged 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 so that the economy will continue to grow strongly. Furthermore, the Committee is taking additional steps as necessary in order to make monetary policy more accommodative.