Remarks by the Governor of the Bank of Israel at the press briefing on monetary policy held today at the Bank of Israel
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. This was the first interest rate decision of 2018. Although we currently do not have all the full year data for 2017, we can give an initial summary at this point of the relevant economic developments in 2017, and analyze how they are expected to impact on developments in the coming year and on monetary policy.
The year 2017 was a good one for the Israeli economy. This year as well, the low inflation rate did not reflect weak demand, and updated assessments are that the economy grew by 3 percent. The GDP per capita growth rate is relatively low compared to some OECD countries. However, this is a result of Israel’s economy being near full employment, as I will show later, while some advanced economies are still closing the output gap that opened during the years of the crisis. In a situation of full employment, the economy’s potential growth depends on the growth rate of factor inputs and on productivity. Therefore, as the Bank of Israel has been showing for some time, it is important to invest in the potential—physical capital, human capital, and the business environment—in order to make rapid growth in the coming years possible. From the demand side, the low inflation environment and the continued accommodative monetary policy in some major economies are expected to lead to monetary policy remaining accommodative in Israel as well, and fiscal policy is also expected to be relatively expansionary.
In 2017, for the first time in three years, the inflation rate was positive during most of the year, but the inflation environment remained below the target. The step-up of the inflation rate compared with previous years was supported by the reversal in the direction of energy prices, some acceleration of the pace of increase in rents, and rising wages. In contrast, several factors acted to reduce the inflation rate: the appreciation led to prices of tradable goods continuing to decline, against the background of inflation among our trading partners remaining relatively low, though higher than in Israel; changes in consumer behavior and in the extent of competition in the economy continue to work toward lowering prices, as do the price reductions initiated by the government. Beyond their direct impact, these forces apparently impact indirectly as well on the inflation environment. Forecasts and expectations from the various sources indicate that inflation will ultimately stabilize within the target range, and the accommodative monetary policy will support that, though the assessments differ on the length of time that the process is expected to take. Inflation expectations for longer terms remain anchored within the target range.
Economic activity continued to expand this year. Quarterly data were relatively volatile, primarily due to fluctuations in vehicle imports, though it appears that on average the economy grew by a rate of approximately 3 percent—in line with assessments of its potential growth. Net of the impact of vehicle imports—which was reflected in an acceleration in growth at the end of 2016 and a slowing of growth in early 2017—there apparently was even some pick-up in growth in 2017. While in the beginning of the year there was an acceleration in the growth rate of exports, it currently seems that the share of exports in GDP did not markedly increase: services exports grew at a solid pace, while goods exports continued to stagnate, despite the rapid increase in world trade, and against the background of continued appreciation of the shekel. Current private consumption is still a major component of growth, supported by an increase in income, which is expected to continue supporting it in 2018 as well. The main evidence of the resilience of real activity is the positive picture conveyed by the labor market. Essentially, there is increasing evidence that we are in a tight labor market. Beyond the continued decline in unemployment across all levels of schooling, the high labor force participation rate and employment rate, and wage increases, the tight labor market is also reflected in the decline in the share of employed people working in a part time position though they would prefer to work in a full time position, the decline in the share of those giving up on seeking work, and in the continuing increase in the job vacancy rate. In this regard, the crisis at pharmaceutical company Teva is certainly a difficult event in terms of the workers expected to be laid off, but the strong labor market is expected to impact positively on the ability of the laid off workers to be absorbed in other places of work, and from an economy-wide perspective the crisis is not expected to have broad effects. Against this background, it is important to reemphasize the need for an active labor market policy, including expanded investment in professional training and placement, and improving the safety net for the unemployed.
The housing market cooled off in 2017, in terms of both demand and supply. The rate of increase in prices moderated, the number of transactions declined, and in parallel there was a decline in new mortgage volume compared with 2016. The interest rate on mortgages changed its trend, declining slightly until it stabilized. It may be assessed that to some extent the decline in demand is an outcome of government activity in the housing market; over time, the basic demand is determined by demographic need, and supply has to provide a response. There was a decline in building starts in recent months, though some upward revision in the data is expected; the increase in building completions and in the number of permits (an indicator of future building starts) point to an increase in supply, and the government has to continue taking action to accelerate the pace of land being released and of planning and construction.
The year 2017 was the first one in a long time in which the economic improvement encompassed most economies, and in which most forecasts were revised upward. After prolonged stagnation, world trade returned to growth at a solid pace, and prices in most financial markets rose. The accommodative monetary policy played a significant role in the recovery, and to date central banks have not attained their inflation targets. As such, policy makers are not rushing to back away from it—in Europe the quantitative easing will continue, though at a smaller scope than before; in the US the federal funds rate is being increased gradually, and to date has not caused the dollar to strengthen. The cautious forecasts in the beginning of the year were impacted to a great extent by political developments, as there was concern they would weigh on the economic improvement—we note, for example, Brexit, US election results, and the elections in France. Some of the political risks dissipated or diminished, and in contrast new risks developed. In any case, the base scenario in most assessments was that the global economic recovery will continue in 2018, as will the monetary policy normalization in the US and in several other economies, while policy in Europe, Japan, and other economies will remain very accommodative.
The appreciation in the effective exchange rate continued in 2017. Most of the appreciation occurred in the first two months of the year, and halted against the background of significant intervention by the Bank of Israel in the foreign exchange market in a short period of time. Since then, despite fluctuations in both directions, the effective exchange rate has been relatively stable. The fluctuations are also the result of changes in cross exchange rates; since the beginning of 2017 the shekel strengthened by approximately 11 percent against the dollar and by 5 percent in effective exchange rate terms, but weakened, for example, by approximately 1.5 percent against the euro. Over time, the relevant exchange rate for examining the competitiveness of exports is the effective exchange rate, though it should be taken into account that volatility in cross rates also has on effect on corporate profits, beyond the impact of the effective appreciation, as most companies cannot adjust their export target markets in the short periods of time characterizing exchange rate fluctuations. Notwithstanding the improvement in the state of the economy, which is a basic factor in the strengthening of the shekel, the level of the exchange rate remains overvalued. The “natural gas plan” of intervention in the foreign exchange market will continue in 2018 as well, and the Bank of Israel will continue to intervene in the market, as it has done recently, so long as there are exchange rate fluctuations that are not in line with economic fundamentals.
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. For the first time, the forecast for 2019 was published as well. GDP is expected to grow by about 3.5 percent per year in 2018 and 2019, against the background of expected continued recovery in world trade and with continued growth in investment in the economy. As noted in the forecast’s release, it is also positively impacted in each of the two years by one-off factors that are expected to affect growth. Similar to the previous forecast, the annual inflation rate is expected to enter the target range in the second half of 2018, and the interest rate path did not change. I refer you again to the staff forecast document that was published by the Research Department, with fan charts depicting the wide range of uncertainty characterizing the forecasts for the various variables.
In conclusion, the accommodative monetary policy is expected to continue in the coming year as well, so long as necessary to entrench the inflation environment within the target range. The continued improvement in the global economy and the solid domestic demand are expected to lead to continued economic growth in 2018, as well, at a solid pace, in accordance with that derived from growth in factor inputs and productivity. Policy measures that expand the economy’s production capacity will allow a continuation of sustainable increase in growth and in the standard of living over time.