To PresentationAs you know, the Monetary Committee today decided to continue its accommodative monetary policy and keep the interest rate at 0.1 percent. The Research Department published its updated macroeconomic staff forecast, which includes for the first time a forecast for 2018 as well, and I will refer to it later on.
The previous time we met here, the inflation environment was still very low, but we assessed that the improvement in the real economy continued in the third quarter, and that in fact turned out to be the case when data for the quarter were published. The US elections were a great unknown to us at the time, and now too there are various assessments regarding the medium and long term ramifications of the results, though the short-term impact on financial markets has already been seen.
The picture being conveyed to us at this time is that the economy continues to grow at a solid pace and the labor market is strong, while the inflation environment remains very low.
In recent months, the direct effects of administrative price reductions and the decline of energy prices on inflation have begun to dissipate. The annual rate of inflation has begun to increase slowly, though the increase halted in the November CPI reading. Although energy prices have had virtually no direct impact on the CPI over the preceding 12 months, and despite the effect of administrative price reductions having been nearly exhausted, wage increases are still not leading to an increase in inflation. It is likely that the decline in commodity prices that occurred through the end of 2015 still enables manufacturers to absorb the wage increase, though in recent months commodity prices have again begun to increase. It is also likely that structural processes of increasing competition, and possibly exposure to private imports via the Internet as well, for the time being are also delaying an increase in prices. The low inflation is also partly the result of the effective appreciation. In any case, it is clear that inflation remaining low does not derive from low demand, as it is occurring in tandem with solid growth in private consumption, a labor market near to full employment, and wage increases. Short term expectations are still low, and to some extent declined due to the surprise to the downside in the November CPI reading. It also impacted somewhat on some medium and long term inflation expectations, which have increased since the US elections, and continue to be anchored within the target range.
In the third quarter, as noted, economic activity continued to grow at an adequate pace, and the indicators we see enable us to assess that the economy continued to increase at an adequate pace in the fourth quarter as well, supported by the accommodative monetary policy. Growth in 2016 was based primarily on private consumption and investment. Consumption was impacted on by the high rate of growth in employment and wages, as well as by the low interest rate. Investment, which increased by more than the investment in vehicles, will increase the future production capacity of the business sector. There are two separate trends in exports: services exports returned to growth at a solid pace, while goods exports, which grew in the second quarter, returned to contraction in the third quarter, so that over time it has been at a virtual standstill, against the background of weakness in world trade and the effective appreciation of the shekel. It is important to recall that export industries are productivity drivers of the Israeli economy, and the ability of exports to recover will allow Israel’s economy to benefit from healthier growth over time. The two-year budget that was approved in the Knesset last week is somewhat expansionary, as it aims at a deficit target higher than this year’s, and therefore will provide support for growth in the short term. Labor market strength continues to be reflected in all parameters of wage and employment.
The global economy continues to grow by a moderate rate, with major blocs moving in contrasting directions. In the US, growth improved in the second half of the year, the labor market is in a good state, and inflation is approaching the target. Following the surprising US election results, market developments were also not what was expected beforehand, and so far are reflected in an increase in yields, an increase in stock market indices, and marked strengthening of the dollar. All these enabled the Federal Reserve, as expected, to increase the federal funds target rate by one-quarter of a percentage point, and it signaled an interest rate path that is slightly higher than what was assessed to date. In contrast, in Europe the recovery is slow, and its economy faces numerous political risks. The ECB extended the horizon of its quantitative easing this month, and the euro continues to weaken markedly. Israel’s economy is very affected by developments in both the US and Europe. Weakness in Europe and the weakness of the euro negatively impact on goods exports, for which Europe is a main destination; the recovery in the US, to the extent that it persists, will be good news for the global economy overall, and for Israel’s economy in particular. However, in various countries worldwide there are continuing processes that are likely to lead to a trend of increased restrictions on world trade; these processes are expected to negatively impact the global economy overall, and in particular small and open economies such as Israel’s.
The appreciation in the effective exchange rate continues, and over the past year it was more than five percent. Against the dollar, the shekel fluctuated without a trend in the year, despite the strengthening of the dollar worldwide, and it may be assessed that the interest rate gap expected to open between the dollar and the shekel is expected to act toward the shekel’s weakening against the dollar. In contrast, the depreciation of the euro, the pound sterling and other currencies less significant in terms of Israel’s trade impacted on the exchange rate of the shekel against those currencies, a process that reflects partly the Israeli economy’s performance being markedly better than other economies, and partly the aggressive monetary accommodation adopted by some central banks. In either case, the appreciation weighs on Israeli exports.
The Bank of Israel’s policy in the foreign exchange market is not intended to act against fundamental forces, but it does moderate the forces for appreciation and buys time for exporters to make the adjustments for long term changes in export markets, which at times are seen rapidly in the currency markets. Thus, the policy supports the recovery of exports, and is an integral part of monetary policy.
In the housing market as well there are trends moving in opposite directions. The pace of building starts returned to increase, and in the past year, according to updated figures, there were more than 50,000 building starts; the supply of unsold homes is at record levels, and the number of transactions is declining, with an emphasis on purchases by investors. The increase in mortgage interest rates led to a moderate but continued decline in monthly volume of new mortgages. All these are forces that are expected to act toward moderation of prices, but so far prices continue to increase at a relatively rapid rate. The duration of construction becoming longer, and building completion data not maintaining the pace of building starts, is troubling, and the government will need to continue working intensively to persist in increasing supply.
The macroeconomic staff forecast presented by the Research Department to the Monetary Committee and published today (recall that it is a conditional forecast based on assumptions regarding exogenous variables) incorporates a more optimistic estimate in terms of 2016 growth, in view of what retroactively turned out to be first half growth that was higher than known at the time the previous forecast was compiled, and in light of the strong third quarter data—the assessment is that the economy grew by 3.5 percent in 2016, by 3.2 percent 2017, and in 2018, for which this is the first forecast, by 3.1 percent. The interest rate and inflation paths are similar to those in the previous forecast—the Research Department continues to assess that the interest rate will begin to rise by a slow rate at the end of 2017. According to the forecast, inflation is expected to reach the lower bound of the target range in about a year.
In conclusion, in the fourth quarter as well, monetary policy acted against the background of several processes whose impacts on the policy are not uniform. While economic activity in Israel is becoming entrenched, and the labor market continues to show strength, the inflation environment is still low and the inflation rate is markedly lower than the target. Political processes in various countries worldwide continue to impart uncertainty regarding expected developments in the global economy, and the divergence in monetary policy between the US and other major economies is widening. Against the background of these factors, the appreciation in the effective exchange rate is continuing. The picture that is becoming apparent is that in terms of real activity, the Israeli economy’s business cycle is more in line with that of the US economy; in contrast, the picture of inflation in Israel is similar to that in Europe. It is important to note that the Bank of Israel’s monetary policy does not necessarily move in line with what is occurring in a specific economy, but is established through analysis of the range of developments and their impact on the Israeli economy and financial markets in Israel.
The Monetary Committee assesses that monetary policy will remain accommodative for a considerable time, in order to support the return of inflation to within the target range. The policy of foreign exchange purchases will continue, as necessary, to support the attainment of policy goals.
It turns out this year that we hold these press briefings at festive times of the year. Our previous meeting was on the eve of the Jewish New Year (Rosh Hashana), and our next meeting will be around the eve of Passover.
Until then, Happy Chanukah to all!