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 monetary policy. Since our previous interest rate decision, at the end of August, there has been a marked deterioration in the health situation. While in the summer months we saw recovery in activity and the economy returned to functioning, even if under a “coronavirus routine”, the increase in morbidity and the second lockdown led again to a negative turnaround in economic activity, similar to what was described in the pessimistic scenario in the forecast published by the Research Department at the end of August. In the discussions, the Monetary Committee was presented with various analyses of the actual and forecast impacts of the lockdown and the exit process on economic activity and inflation, as well as on the financial system, particularly the credit market. At the end of the discussions, the Committee decided to keep the interest rate unchanged, and to enhance the extent of monetary accommodation through the expansion of the government-bond purchase program by NIS 35 billion. In addition, the Committee decided on an additional pillar in the program to extend credit to banks against loans to small and micro businesses. As part of that, the Bank of Israel will provide the banking system with fixed-rate loans at negative 0.1 percent, against loans extended by the banks to small and micro businesses at an interest rate that does not exceed Prime + 1.3 percent. I will now describe how we view the situation through the discussions and our decisions.
During the summer months, the recovery in economic activity, which began at the end of April, continued. Various indicators available to us show that before the lockdown there was an improvement in businesses’ expectations regarding activity, and the share of business that assessed that there is a high risk that they will not succeed in surviving the crisis declined. The negative impact on revenue decreased, with an emphasis on large companies. Credit card purchases, electricity usage data, and the Composite State of the Economy Index, the Bank of Israel’s Companies Survey, and the Business Tendency Survey conducted by the Central Bureau of Statistics, also supported the assessment that the economy is recovering, and our assessment regarding the scope of inactivity in the economy decreased to 5–7 percent. The improvement was also reflected in the labor market, and the broad unemployment rate stabilized around 11–12 percent, a relatively low rate compared to what it was at the peak of the crisis, though far from reflecting a healthy economic situation. Exports were mixed—services exports, except for tourism, of course, maintained their strength, while goods exports data remained relatively weak.
The summer’s good data are expected to be reflected in high third-quarter growth, which will reflect recovery in contrast to the second quarter’s decline in GDP. However, the sharp deterioration in the morbidity situation at the end of August and beginning of September, and the government’s decision to impose an additional lockdown, led, as expected, to a marked worsening of economic activity. As of now, it appears that deterioration was less severe than what we experienced in March–April, but the rapid indicators that we developed with the outbreak of the crisis, such as credit card purchases, mobility data, and electricity consumption, point to a sharp decline in economic activity with the entry into the lockdown. The closure of businesses is immediately reflected in the labor market—the Central Bureau of Statistics reports that the broad unemployment rate rose sharply in the second half of September, to approximately 19 percent, meaning 300,000 Israelis returned to the circle of unpaid leave or unemployment, in addition to many self-employed people whose income was adversely impacted. At this stage, it is difficult to know what the labor market’s pace of recovery will be in the exit from the lockdown.
The nature of the crisis leads to its effects not being uniform, and the adverse impact is concentrated in industries that are directly affected by the limitations on activity and the social distancing requirements—such as the events, restaurants, culture and entertainment, and tourism industries. The risk for these industries and for households whose income depends on them is considerable, and the variation in risk between the various sectors is liable to increase as the crisis continues. This feature of the crisis highlights the important role of fiscal policy. The negative impact on the labor market is formidable, and it is important to take policy steps that will allow the return of as many employees as possible to the workforce, including the implementation of professional training programs. As I have said several times in the past, the coronavirus crisis found the Israeli economy in a strong position, and in particular, we benefited from a low debt to GDP ratio and fiscal credibility that were achieved over many years. These enabled the government to increase government expenditure by unprecedented orders of magnitude within the framework of providing an economic and health-related response to the crisis. However, the ramifications of the crisis have already led to a sharp increase in the deficit, which is expected to increase further, and with it the debt to GDP ratio. Therefore, the government must manage its priorities and initiate steps that will allow investment in growth drivers and improvement in productivity in the medium and long terms, and in parallel plan the manner of the economy’s return to the path of sustainable fiscal policy in the years after the crisis. Accordingly, I reiterate the necessity of presenting a comprehensive economic plan, which will be reflected in the government budget for 2021, which should be presented and approved by the Knesset as soon as possible.
Based on the Research Department’s updated macroeconomic forecast, the negative impact on economic activity will continue to be considerable. The Research Department continues to present two scenarios for its forecast—the optimistic scenario, in which control over infection will be achieved, assumes that the exit from the lockdown will be relatively rapid, and that over the remainder of the year, morbidity will stabilize at a level low enough to allow reasonable activity in industries that are not characterized by gatherings. Under this scenario, GDP is expected to contract by 5 percent in 2020, and the recovery, which will begin already at the end of 2020, will lead to growth of 6.5 percent in 2021. Despite the recovery, the level of activity at the end of 2021 will be approximately 5 percent lower compared with the pre-crisis trend, and the broad unemployment rate will decline gradually to 7.8 percent at the end of 2021. The inflation rate will increase moderately but will remain below the target. Under a more pessimistic scenario, which assumes that several further waves of infection are expected, which will lead to a contraction of economic activity, negative growth of 6.5 percent is expected in 2020, and a much later recovery will bring growth to only 1 percent in 2021, and a broad unemployment rate of 13.9 percent at the end of 2021. In this scenario, inflation is also expected to be lower. The Research Department assesses that the Bank of Israel interest rate will be 0–0.1 percent. However, to the extent that there is a deterioration, and particularly if the more severe scenario plays out, the Bank of Israel will be able to utilize a range of tools, including the option of an additional reduction in the interest rate, in line with developments. I again emphasize that what is important in the forecast is not necessarily the precise numbers, but the orders of magnitude that should serve all of us in preparing policy, monetary as well as fiscal.
The global economy also showed improvement during the third quarter in view of the decline in scopes of morbidity and the easing of lockdown policies, though with great variation among the economies. The improvement was stronger in the US than in Europe and Japan, and China’s economy is notably good in light of its success in dealing with the health crisis. The improvement in activity led as well to an upward revision in the IMFs’ forecast, which currently expects a contraction of 4.4 percent in the global economy in 2020. With that, in many economies the return of economic activity came at a cost of increased morbidity, and led to governments renewing limitations on gatherings that are expected to lead to a halt in the economic recovery. As of now, the scope of mortality and the number of severely ill patients are lower than those in the first wave, so that governments are expected to allow limited economic activity under a coronavirus routine, which will support continued improvement in manufacturing and in world trade. In contrast, the political uncertainty in the world has returned to the front of the stage and is weighing on the potential for recovery, in view of the difficulties in the Brexit process and a possible worsening of the trade war between the US and China.
Central banks continue to adopt very accommodative policy, and are signaling their readiness to take additional steps. The Federal Reserve announced a change in its monetary strategy, which means that in the coming years it will conduct accommodative policy for a longer period of time. The ECB is expected to increase its asset purchase program, and the Bank of England is hinting at the possibility of enhancing its monetary accommodation. Central banks are emphasizing the decline in the inflation rate as a main factor in the accommodative policy, beyond the need to support financial conditions and economic activity.
Financial markets in Israel continue to function in an orderly manner, and the second lockdown did not lead to the intense market volatility that we experienced in the first lockdown. Government bond yields generally have remained very low, among other things against the background of Bank of Israel activity in the market, but the real yield is high in international comparison in view of the low inflation environment in Israel. Corporate bond spreads remained stable and in some sectors there was even a slight decline. The credit market, a critical component in the ability of businesses and households to endure the crisis with minimal negative impact, is fulfilling its role appropriately: after declining in the beginning of the crisis, credit to small businesses increased moderately, supported by the Ministry of Finance’s government-guaranteed credit funds and the Bank of Israel’s program to extend inexpensive credit to banks against their extending credit to small businesses; consumer credit is stabilizing at a lower level than before the crisis, and it is reasonable to assume that this has been caused by a decline in demand; commercial credit soared at the outset of the crisis when many companies were quick to utilize available credit facilities, and then some of them apparently paid back the credit when markets calmed down. However, the low demand for commercial credit could also reflect companies’ lack of certainty regarding the path of economic recovery and as a result the worthwhileness of making investments. Housing credit continues to grow. The outline for deferring loan repayments, which was recently renewed and includes credit card companies as well, essentially provides additional credit for households and companies that need it. In all the sectors, despite the increase in risk, the average interest rate remains stable or has even declined, supported by the Bank of Israel’s accommodative monetary policy.
The inflation environment continues to be very low. The low level of demand in the economy, the low inflation worldwide, and developments in the exchange rate, all point to inflation being expected to remain low for an extended period of time. One-year inflation expectations declined further due to the decision on the lockdown and a decrease in crude oil prices worldwide. In the coming months the inflation rate is expected to remain negative, and then to increase moderately. Based on expectations derived from the capital market, the return of inflation to within the target range will take more than 2 years, and even though long-term expectations declined slightly, they remain anchored within the target range. A Research Department analysis shows that even if the measurement of inflation would take into account the changes in the household consumption basket due to the crisis, the inflation picture would not change markedly.
Since the outbreak of the crisis, the Bank of Israel has been taking unprecedented policy steps to support the orderly functioning of the financial markets and to make things easier for credit consumers in the economy. The low interest rate, as well as the impact of purchases of government and corporate bonds, and the program to extend inexpensive credit to banks against loans to small businesses, is spread out over a range of borrowers in the economy and allows a flow of inexpensive credit to customers who have the ability to repay it. In parallel, the government-guaranteed credit funds, which were expanded recently, help small businesses that are at high risk.
In the past 2 months, the shekel has traded with no clear trend: it weakened in September, but the appreciation renewed in October. In general, the effective exchange rate has moved in a relatively narrow range since May, despite the volatility in cross rates. The Bank of Israel will continue to intervene in the foreign exchange market so long as the Committee is of the opinion that the exchange rate has deviated from the window that is consistent with price stability and adequate economic activity.
At the end of the discussions, the Monetary Committee decided to keep the interest rate at its low level of 0.1 percent, and to expand the government-bond purchase program by NIS 35 billion. This program has an important role in stabilizing financial markets since the onset of the crisis, and it supports convenient credit terms for all borrowers in the economy. In view of the continuation of the health crisis in Israel and worldwide, and its continuing ramifications on the economic situation, the Monetary Committee was of the opinion that it is proper to expand the scope of the program, in order to ensure that the economy’s credit needs continue to receive a response via a convenient interest rate environment along the entire curve, and that the monetary policy provides the required support for real activity and inflation at this time. In addition, as the negative impact of the crisis is particularly severe among many small businesses, the Committee saw a particular need to ensure convenient credit terms for such businesses. Therefore, the Committee decided on another pillar in the plan to extend credit to banks against loans to small businesses. Within this framework, the Bank of Israel will provide the banking system with fixed-rate loans at negative 0.1 percent, against loans that are extended by the banks to small and micro businesses at an interest rate that does not exceed Prime +1.3 percent.
Israel’s economy is facing a complex and challenging reality. All decision makers must display creativity and dedication in formulating and implementing policy that will reduce, to the extent possible, the negative impacts of the crisis, and will place the economy in the best possible position for robust and sustainable growth when exiting the crisis. The Bank of Israel will continue to act in all its areas of responsibility to ensure the orderly activity of the financial system and to support economic recovery.