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 Policy Committee held discussions at the Bank of Israel in order to decide on monetary policy. The picture of the battle against the coronavirus can be said to have changed for the better since our previous monetary policy decision, at the end of February. Morbidity rates have declined markedly, helping the economy to re-open and in some areas to return to its state before the coronavirus outbreak. We see this in the economic indicators, as well as each of us seeing this in our own daily lives. These developments are very encouraging, and I hope that this trend continues in Israel and worldwide, so that the light at the end of the tunnel continues to strengthen. However, the economic impacts of the pandemic are still with us, and will continue to be with us for some time. In the economy’s current state, the focus should be on the immediate processes necessary for exiting the crisis as smoothly as possible, while emphasizing the survival of businesses and dealing with employment. I will expand on this shortly. In parallel, there is an immediate need to plan, initiate, and budget, in a fiscally responsible manner, the structural reforms that the economy needs in order to provide economic growth in the post-crisis years as well. These need to be the priority of any government that is established. As such, the Monetary Policy Committee will have to design its policy so that it continues to provide macroeconomic support to the exit from the economic crisis, and to ensure that the credit market continues to function well, with stable and low interest rates, and that the credit supply remains adequate. The Committee analyzed the economic developments of recent months and the policy required in the coming period and assessed their overall impact on economic activity and inflation, and decided to keep the interest rate unchanged at its low level of 0.1 percent, while the Bank of Israel will continue to operate a wide range of policy instruments as it has done throughout the crisis. I will now go into detail about the current picture as presented to the Committee and the considerations that led to the decision.
In 2020, the crisis and the lockdowns led to Israel’s GDP contracting by a deep and unprecedented rate of 2.6 percent, and GDP per capita contracting by 4.4 percent. From an international perspective, it was a relatively small contraction of GDP, indicating the resilience and dynamism of the Israeli economy. This outcome is due, in large part, to the high tech industries that continued to lead and even to expand, as well as fiscal support in the form of government assistance during the crisis that prevented an even larger contraction, in spite of the fact that Israel imposed severe restrictions that went into effect during the crisis. Although 2021 began with an additional lockdown, currently available data show that the level of economic activity in March was the highest since the beginning of the crisis last year, and the economy’s current recovery is more rapid than that of most advanced economies.
Recall that in the beginning of January, the Research Department published two scenarios (one optimistic and one pessimistic) for the macroeconomic forecast, and as of now it appears that the optimistic scenario of a rapid pace of vaccinating the population is materializing. Accordingly, the data available for the first quarter are encouraging. Since the exit from the third lockdown and the relaxing of the restrictions, there has been a recovery in economic activity in areas that were markedly adversely impacted by the restrictions, such as internal tourism, restaurants, trade leisure services and education. Labor Force Survey data for the first half of March indicated a decline in the broad unemployment rate from a level of 19 percent in February to around 12 percent. In terms of employment we are still far from where we want to be. We see that in March the number of job vacancies increased markedly and businesses reported increased difficulty in recruiting workers. Yet despite the increase in the activity and the gradual return to the circle of employment, the return of the unemployment rate to the low pre-crisis levels is expected to take an extended time. This is in view of the number of businesses that closed over the last year, the restrictions that remain, the activities that are still closed, such as tourism from abroad, and the processes of increasing efficiency and of digitization that businesses went through during the past year. In view of this, it is important to take focused policy steps in this area, including professional training and dedicated programs for population groups that were particularly negatively impacted.
According to the Research Department’s updated macroeconomic forecast, the level of GDP in 2021–22 is expected to be higher that the rapid-vaccination scenario presented in January. According to the forecast, GDP is expected to grow by 6.3 percent in 2021 and by 5 percent in 2022. The actual decline of GDP in 2020 was less than the Department had projected in the previous forecast, and as a result, although the 2021 forecast did not change, the level of GDP at the end of 2021 is expected to be higher that in the previous forecast. This is also true for GDP in 2022. The meaning of this growth is that the level of GDP at the end of 2022 is expected to be only approximately 1.4 percent lower than the level that was expected before the crisis, so that by the end of 2022 the Israeli economy is expected to have almost fully cancelled out the crisis’s impact on GDP level. The Department’s decision to present only one baseline scenario this time indicates the decline in the level of health-related uncertainty we have been dealing with until now, and is certainly a positive development in view of the events of the past year and the severe crisis that we have experienced. However, we must remember that there may still be “negative surprises”—such as a Covid-19 variant that is resistant to the vaccines or if it turns out that the extent of the vaccine’s impact is shorter than currently assessed. These would of course have a negative impact on economic developments. In addition, the forecast is exposed to uncertainty deriving from the political instability and its ramifications on the policy path that will be adopted by the next government in all that relates to the specific spending budgets for various programs dealing with the Covid-19 crisis, the budget, the deficit, and economic policy. Therefore, the highest priority economic task for any government that is established will be to pass the 2021 budget, and to promote the approval of the 2022 budget on time, in order to establish economic priorities, and to initiate the reforms and long-term investments that are essential to accelerating the economy.
The inflation environment continues to increase moderately against the background of the economic recovery in Israel and abroad, the increase in commodity prices, and the stabilization of the exchange rate. Recent CPI readings surprised to the upside, and based on current forecasts, by May inflation is expected to return to the target range. Inflation expectations entered the target range, with expectations for longer terms already anchored at the center of the range. When we come to analyze the development of inflation later on, we will need to understand if this is in fact an increase in the inflation environment, or if the increase in prices is only a transitory correction to the low price levels that were seen during the course of the crisis. In any case, this is clearly not an outbreak of inflation, and the accommodative monetary policy will continue to support employment and the economy’s recovery from the crisis.
With regard to the foreign exchange market, at the end of 2020 and the beginning of 2021, there was a sharp shekel appreciation due to the strengthening of the foreign currency flows into the economy. This was against the background of the growth in direct investments in Israel, foreign exchange sales by institutional investors against their overseas capital market profits, an increase in nonresidents’ investments in Israeli government bonds, as well as the growth in the current-account surplus, part of which may be explained by transitory factors. The Monetary Committee’s decision on its foreign exchange purchase program for 2021, at an unprecedented scope of $30 billion, supports the continued exit from the crisis and the goal of returning inflation to within its target range. We will continue to implement this program as we announced, and will even expand it if necessary, in accordance with economic conditions and development.
Financial markets in Israel continue to function in an orderly fashion. The trend of rising equity prices continues in capital markets in Israel and abroad, and major global indices are at record highs. In the government bond market, there is a slight increase in yields, and corporate bond spreads continued to narrow, and are close to their pre-crisis levels. The rate of issues in the equity market continues to be high and there was a sharp increase in capital raised in the venture capital sector in the first quarter. The credit market is also functioning well at a stable and low interest rate level, supported by a range of steps taken by the Bank of Israel and the Ministry of Finance. Further evidence of the process of the economy returning to its robust level is that in February and March, for the first time since the beginning of the crisis, there was a decline in the average level of the difficulty in obtaining credit, to levels seen just before the crisis. The return to pre-crisis levels is seen in all industries except for the hotels industry which still reports relatively high levels of difficulty in obtaining credit, according to the Business Tendency Survey of the Central Bureau of Statistics.
The global economy is also showing an improvement, and the increase in the pace of vaccination worldwide is assisting the recovery. The IMF updated its growth forecasts upward in all major economic regions, and in 2021, the global economy is expected to grow by about 6 percent. Global output is expected to be about 3 percent lower than the forecast before the crisis. World trade continues to grow and its level is higher than before the crisis. The global Purchasing Managers Index increased to a level it had not been at since 2018 (about 55 points), a level that indicates a marked expansion in economic activity. The expansion in activity was reflected both in services components and in manufacturing components. The inflation rate increased in all major regions, and short term expectations increased, which is expected to moderate slightly going forward. However, core indices remained lower than central banks’ targets and monetary policy at the major central banks continues to be very accommodative.
At the end of the discussions, the Monetary Committee decided to keep the interest rate unchanged. In parallel, the Bank of Israel continues to utilize the entire arsenal of monetary tools that we have operated throughout the crisis—bond purchases, special loan programs for increasing the supply of credit to small businesses, and intervention in accordance with the foreign exchange purchase program. In this way, the very accommodative monetary policy will continue to accompany the Israeli economy’s exit from the economic crisis.