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. At the end of the discussions, the Monetary Committee decided to increase the interest rate to 0.35 percent
When we were making the monetary policy decision, and in preliminary discussions that were held ahead of the decision, the Monetary Committee members and I analyzed the state of the economy and the various developments in Israel and abroad. We continue to see a robust Israeli economy, which has nearly completely erased the effects of the pandemic. The output gap has essentially closed, and the labor market has also nearly completely recovered, with a high employment rate alongside solid demand for employees. The strong growth is particularly notable compared to other advanced economies. These are results that characterize a dynamic economy, with the ability to adjust to various economic situations and challenges. Of course, we also analyzed developments in inflation—which is rising worldwide as well as in Israel, financial market developments, the state of morbidity, and the geopolitical situation. I will expand on all these and more immediately.
The last COVID-19 wave taught us that the virus is still here, and will accompany us going forward. However, at this point we can say with a high degree of confidence that the economy has adjusted to the new situation, and the public has learned how to deal with the virus and the morbidity, and how to have an active and growing economy alongside them.
As part of the global recovery from the crisis, demand for products has been strong, but it is hard for supply to respond to this increased demand due to difficulties in renewing production activity worldwide. Among some parts of the population there has been an increase in disposable income, and with it an increase in demand with the removal of the limitations to deal with the pandemic. This process, which in the beginning was assessed worldwide to be only a transitory factor that was expected to pass quickly and balance out, has turned out to be a factor that has continued for a longer period of time. This reality led to inflation in many countries exceeding the target and it led central banks to start tightening monetary policy. Similarly in Israel, inflation has recently exceeded the target range, though inflation in Israel was and still is markedly lower than the inflation rate in most OECD countries. In the second half of 2021, the Monetary Committee began a process of gradually contracting the monetary accommodation. We announced the gradual halt to the operation of the special tools that we had operated at the peak of the COVID-19 crisis: in July 2021, after we saw that there was less need for the designated loan program for small and micro businesses, we announced the end of that program. In November 2021, when we saw that the convenient financing conditions in the economy were being maintained, the Monetary Committee decided to end the programs of buying government and corporate bonds in the markets as well. In addition, the repo transactions that we operated during the crisis were also halted.
The tragic events in Ukraine impact on the global economy and add complexity to the setting of monetary policy. The war is liable to lead to a slowing in the global recovery process and mainly to weigh on the loosening of global production and supply limitations. These developments impact on prices worldwide and particularly on energy prices, and due to that, contribute to increased inflationary pressures. However, it should be noted that the Israeli economy is less impacted by the unfortunate developments in eastern Europe than other countries, in view of the relatively small volume of trade with Russia and Ukraine, and in view of the smaller impact of the gas price increase on the Israeli economy, with natural gas prices in Israel being anchored in long term contracts. This is an important stabilizing factor that has indirect impacts on the development of prices of many products. Other factors that contributed to the lower inflation in Israel than in the rest of the world, are moderate wage increases so far and the shekel appreciation.
The updated macroeconomic forecast published today by the Bank’s Research Department incorporates all the developments I have noted plus others. The Department forecasts that GDP in 2022 will grow by a rate of 5.5 percent, and in 2023 by 4 percent. Based on the forecast, inflation is expected to still exceed the target range at the end of 2022 and to return to the middle of the range at the end of 2023. The employment rate is forecast to continue to increase, and the unemployment rate is expected to continue to decline through the end of 2023. I would like to emphasize that we are in a period of high uncertainty, and accordingly, the Department points to several main risks to the forecast. First, the developments due to the war in Ukraine may have a larger impact on growth, trade, and inflation worldwide; second, the appearance of new variants of the coronavirus may lead to broad waves of morbidity and thus back to limitations on economic activity; and third, the security events we have experienced recently, and the increased political uncertainty, are liable to have an impact on the development of demand and of economic activity.
In recent months, we have seen the expansion of inflation across many items in the CPI. This indicates that alongside supply factors, inflation is also impacted by an increase in the level of demand. This comes against the background of strong economic activity, reflected in a closing of the output gap, a tight labor market, and a decline in the unemployment rate to pre-crisis levels. In view of all these, the Monetary Committee decided that conditions now allow the beginning a gradual process of raising the interest rate. The pace of increasing the interest rate will be determined in accordance with future data on activity and the development of inflation, in order to continue supporting the achieving of policy targets.
Against the background of the decision we reached today, I feel it is correct to recall that part of the goal of monetary policy is to moderate the volatility in the business cycles. The changes in the interest rate are mostly being done within the framework of a gradual process, the goal of which is to moderate the economic fluctuations. At the previous interest rate decision, the Committee presented the public with its assessment that in the coming months the time will allow for a process of increasing the interest rate. In today’s decision, we are essentially continuing this line of a continued and gradual process of monetary contraction, with an emphasis on reducing the inflation rate. I reiterate that the Monetary Committee looks at the overall picture—at the macro level, both domestic and global, as it should when conducting monetary policy.
The central goal of the Bank of Israel is to maintain price stability, and this translates into attaining the inflation target set by the government. However, alongside the discussion of the development of inflation in Israel, it is important to me to also note the cost of living in Israel—reflected in a high level of prices, as opposed to the change in prices, which is inflation. The cost of living is an important issue for Israel’s society and economy, and has an impact on many spheres—consumer goods, home prices, transportation, and more. These affect all of us, and need to be dealt with by the implementation of important reforms, some of which have already been advanced and are being formulated by the government. Naturally, different sectors need different solutions, and these processes take time until they come to fruition. We must remember that the main key for improving the quality of life is increasing productivity in the economy, through acquiring the required skills and with a marked improvement in education, and in physical and technological infrastructures in Israel. I stress all this particularly today, in order to emphasize and to recall that the interest rate is a broad tool and not the designated tool for dealing with the cost of living or with a specific sector.
Before I conclude, I would like to refer as well to capital markets in Israel and worldwide. In the markets, there has been an increase in volatility, and after declines that were recorded with the spike in inflation and the outbreak of war in Ukraine, some equity indices recently returned to an upward trend. Government bond yields rose sharply here in Israel and around the world, partly due to bond markets beginning to price in the change in trend in monetary policy. There were also moderate rises in corporate bond spreads in Israel but they remain low from a historical perspective.
In conclusion, I will add, as always, that the Monetary Committee at the Bank of Israel follows developments in Israel and abroad very closely, and we will continue to conduct appropriate policy in order to meet the various targets and challenges facing us.
Thank you all for joining us today.