As you know, the Monetary Committee decided today to keep the interest rate at 0.1 percent, and reiterated that it intends to maintain the accommodative policy as long as necessary in order to entrench the inflation environment within the target range. Participating in this week’s discussions were the three new Monetary Committee members: Andrew Abir, the Director of the Market Operations Department, and Prof. Zvi Hercowitz and Prof. Moshe Hazan from among the public, who were recently appointed to fill long-vacant positions. I welcome them and wish them much success in their new and important roles. I also wish success to Prof. Michel Strawczynski, the new Director of the Research Department, which today published its updated macroeconomic staff forecast that I will refer to later on.
Israel’s economy has been, for some time, in a relatively unique environment of very low inflation with growth at near its potential rate, and a labor market at full employment. Since we met here at the previous press briefing, there has been considerable volatility in inflation, but overall it remains very low. The moderation in growth is apparently transitory, and we assess that the economy will continue to grow at around its potential rate. A trend of some depreciation of the shekel in terms of the effective exchange rate halted, and recently there has been renewed appreciation. The picture of the global economy appears more optimistic, which is expected to be reflected in a moderate reduction in the extent of monetary easing worldwide. I will now expand on these developments, and how they are expected to impact on policy.
Inflation data in recent months were volatile, as noted, and some of the CPI readings were surprising. However, overall, in the past year there wasn’t a major change in the inflation environment, which remains below the target range, as seen in annual inflation and in short-term expectations. A long term analysis indicates that the moderation of inflation encompasses most components of the CPI, including housing. As we have noted in the past, in addition to the appreciation of the shekel, government measures to reduce the cost of living and changes in consumer behavior and in competition in the economy are acting to reduce prices. Recently, there has also been a moderation in inflation around the world. In contrast, the strong demand will continue to act to increase inflation. Until recently, employers were able to absorb the wage increases in the economy without raising prices, because the decline in prices of inputs, chiefly energy, led to increased wages not being reflected in a similar increase in unit labor cost. The increase in wages did moderate recently; however, as the process of decline in prices of other production factors was exhausted, the wage increase is expected to have an inflationary effect. Long-term expectations didn’t overreact to the short term changes and remained anchored within the target range, and thus reflect market participants’ confidence in the inflation targeting regime.
Data currently available enable us to assess that the slowdown in the growth rate at the beginning of 2017 compared with 2016 (beyond the volatility derived from vehicle imports) was mainly the result of supply constraints, deriving from the labor market being close to a state of full employment, and that the economy is expected to continue to grow at a rate in line with its long term potential. Although there has been some moderation in private consumption, it comes after about two years in which consumption grew at an exceptional pace, and indicators of demand, such as consumer confidence indices and purchasing managers indices, are at high levels. Exports, as is known, have suffered from prolonged stagnation, but for over a year they have grown at an adequate pace driven by services exports, which are less impacted by the exchange rate than are goods exports. This comes against the background of the marked recovery in world trade, which returned to growth at a relatively high pace. Labor market data continue to be very positive. The unemployment rate is declining for all education levels, and together with the high level of number of work hours per employed person they indicate that the labor market is at full employment. The wage increase is volatile but it encompassed most industries, and the Companies Survey indicates that there is an increase in the share of companies reporting that the shortage of professional workers is an effective constraint for them. This highlights the need to take steps now to increase the economy’s long term production capacity as the Bank of Israel has been showing for some time already—investment in infrastructures and in improvement of human capital, improvement in the business environment, and more—precisely due to the good macroeconomic situation.
Home prices renewed their increase in recent months, but at a moderate rate relative to the past, while other indicators continue to point to the market cooling off, such as the low level of number of transactions, and the continued decline in monthly mortgage volume despite a moderate decrease in the interest rate in recent months. To the extent that government efforts to continue increasing the supply of homes continue, they will support the stabilization and subsequent decline of prices.
The global economy’s improvement continues, and international institutions are displaying cautious optimism regarding developments expected in the short term. Last week, representatives of the Bank of Israel and of the Ministry of Finance participated in the annual meeting of the IMF and the World Bank, and those assessments arose not only from official data and projections, but also from meetings we held with policy makers and economists from various countries. There, too, the need to take advantage of the macroeconomic improvement to provide a response to long terms challenges was emphasized. In recent months, the improvement has encompassed most major economies: in the US, the economic effect of weather-related damages is expected to apparently be limited, and the European economy is growing at a relatively high pace despite political challenges. The macroeconomic improvement is also the result of very accommodative monetary policy, so understandably policy makers are very cautious when it comes to retreating from it. In the US, a further increase in the federal funds rate is expected soon, along with a gradual contraction of the Fed’s balance sheet. In Europe, a contraction of the scope of quantitative easing is expected. Inflation in the US and in Europe is markedly higher than in Israel, but even in those locations it does not yet reach central banks’ targets, and the Federal Reserve Chair, in her most recent speech, listed several reasons why the inflation rate persists in remaining low, including, for example, the growth of online purchases, a phenomenon noted by the Bank of Israel as well. In any case, there is no doubt that the low inflation rate leads to the expectation that the exit from monetary accommodation will be very slow.
After the appreciation halted in the first half of the year, with significant intervention by the Bank of Israel in the foreign exchange market, the shekel depreciated by more than 4 percent in terms of the nominal effective exchange rate during the summer. However, since then the depreciation has mostly receded, and the shekel is only slightly weaker than the appreciated level it reached at the beginning of the year. Bank of Israel policy in the foreign exchange market is not intended to offset the portion of the appreciation that results from fundamental factors seen in the strong macroeconomic situation. However, as we have noted in the past, the current level of the exchange rate reflects some overappreciation, resulting from, as I described, monetary policy worldwide remaining highly accommodative. To the extent that monetary policy will tighten abroad, it will support shekel depreciation, though the Bank of Israel’s policy has not changed and the Bank will be able to continue to intervene in the foreign exchange market to the extent it deems necessary to moderate atypical fluctuations that are not in line with fundamental factors.
The Research Department presented its macroeconomic staff forecast (recall that it is a conditional forecast based on assumptions regarding exogenous variables) to the Monetary Committee, and published it today. The relatively low first-half growth data led to a downward revision of the forecast for 2017, to 3.1 percent, but as noted this reflects developments that have already occurred, and there is no change in the growth forecast for 2018: 3.3 percent. The forecast reflects a gradual shift to growth based less on private consumption and more on exports, supported by the improvement in world trade, after recent years when private consumption drove growth. The greater than expected decline in inflation in recent months led to the inflation rate only being expected to enter the target range in the third quarter of 2018, and the interest rate path is slightly lower than what was presented in the previous forecast. I remind you that the Research Department attaches fan charts to the staff forecast document, which describe the broad range of uncertainty that is a feature of the forecast for various variables.
In conclusion, we assess that the monetary policy contributed to the economy being in a strong macroeconomic situation, which the public feels in the low unemployment rate, the increase in wages, and the growth in private consumption. With that, inflation remains low, to a large extent as a result of factors that are positive for the economy. Therefore, even after additional central banks will begin to reduce their monetary accommodation, the Monetary Committee intends to maintain the accommodative policy as long as necessary in order to entrench the inflation environment within the target range.