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Background conditions
Inflation data: The Consumer Price Index (CPI) for October declined by 0.2 percent. Forecasts projected an increase of 0.2 percent, on average. The main reason for the surprise was a sharper than expected decline in the housing and the fruit and vegetables components. The development of actual prices indicates continued moderation of the inflation environment. The rate of inflation over the previous twelve months was 1.8 percent.
Inflation and interest rate forecasts: Forecasts of the inflation rate over the next twelve months based on the average of forecasters' inflation predictions, and inflation expectations based on over-the-counter CPI futures contracts offered by banks, were relatively stable at around the midpoint of the inflation target range. Expectations calculated from the capital markets (break-even inflation) declined this month, from 2.5 percent to 2.2 percent. Inflation expectations for two years and longer declined for shorter terms to 2.3–2.4 percent, and remained stable for longer terms at around 2.5 percent. Expectations for the Bank of Israel interest rate one year from now derived from the Telbor (Tel Aviv Inter-Bank Offered Rate) market as well as expectations based on the average projection of forecasters are for an interest rate of 1.8 percent. All forecasters who provide projections to the Bank of Israel predict that the Bank will keep the interest rate for December unchanged.
Real economic activity: Most indicators of real economic activity that became available this month support the assessment that the moderate growth of activity continues, and is expected to continue in the coming months. National Accounts data for the third quarter indicate that GDP increased by 2.9 percent and business sector product increased by 2.7 percent (in annual terms). Increases of 3.5 percent in private consumption (excluding durable goods) and of 4.6 percent in exports (excluding start-ups and diamonds) contributed to the growth in GDP. With that, there was a decline in demand for consumer durable goods, investment in machinery and equipment, and investment in transport equipment, reflected in a decline in goods and services imports (excluding defense imports) of 12 percent. Similarly, the rate of increase in the Composite State-of-the-Economy Index slowed in recent months, from an average monthly rate of 0.21 percent in January–July (an annualized rate of 2.5 percent), to an average monthly rate of 0.15 percent in August–October (an annualized rate of 1.8 percent). Various surveys of current economic activity and of future expectations (the Business Tendency Survey of the Central Bureau of Statistics, consumer confidence indices, and the Purchasing Managers Index) also indicate a slowdown in the third quarter of 2012 and assessments that the slowdown will continue in the fourth quarter of the year. Consumer confidence indices indicate that in October, the general picture—indicating increased pessimism among consumers with regard to near term developments—did not improve. These background conditions are in line with the Research Department forecast of 3.3 percent GDP growth in 2012 and 3 percent growth in 2013. Last week, Operation "Pillar of Defense" ended, and the Bank of Israel's preliminary assessment is that the operation will have little impact on theeconomy's output.
The labor market: Labor force survey data which became available this month continue to indicate improvement, at a restrained rate, in employment, continued growth in the participation rate, and a continued decline in unemployment. The participation rate in the third quarter increased by 0.6 percentage points compared with the second quarter, to 64.2 percent, and the unemployment rate declined from 6.9 percent to 6.7 percent. The improvement primarily reflected expanded employment in public services—the number of employee posts in public services increased by 0.9 percent in July–August, while there was a decline of 0.4 percent in the number of employee posts in the business sector. Nominal wages increased by 1.1 percent, and real wages increased by 1 percent, in June–August compared with the preceding 3 months, based on seasonally adjusted figures. Health tax receipts, which provide an indication of nominal wage payments, were 6.5 percent higher in September–October than in the corresponding period of the previous year, compared with a year over year increase of 7.1 percent in July–August.
The Bank of Israel Research Department staff forecast: The Bank of Israel Research Department's macroeconomic forecast for 2012 and 2013 was published in September. The forecast (which was published as a separate press release together with the interest rate notice for October) projected GDP growth of 3.3 percent in 2012 and 3 percent in 2013. According to the forecast, the inflation rate in 2013 is expected to be 2.2 percent. Some decline in the inflation environment over recent months is likely to support a downward revision of the inflation forecast for the coming year, within the framework of the forecast which will be published with the interest rate notice for January.
Budget data: The deficit in domestic government activity totaled about NIS 17.9 billion in January–October, some NIS 6.1 billion greater than the seasonal path consistent with the Ministry of Finance's deficit forecast (3.4 percent of GDP). The gap primarily reflects a shortfall in tax collection as well as high expenditure. Based on developments to date, the deficit for the full year is projected to reach about 4 percent of GDP, assuming that government expenditure does not surpass the original amount in the budget. An analysis of expected debt repayments by the government for 2013 shows a decline in the repayment amount compared with 2012. Thus, the limitation of expenditure to one-twelfth of the previous year's budget until a new budget for 2013 is passed will have a relatively small effect on other government expenditures.
The foreign exchange market: From the previous monetary policy discussion held on October 28, 2012, through November 23, 2012, the shekel was unchanged against the dollar—with volatility during Operation "Pillar of Defense"—in contrast with most major currencies, which weakened against the dollar. The shekel weakened by 0.2 percent against the euro. In terms of the nominal effective exchange rate the shekel appreciated by about 0.2 percent.
The capital and money markets: From the previous monetary policy discussion held on October 28, 2012, through November 23, 2012, the Tel Aviv 25 Index increased by about 0.2 percent, in contrast to the declines in most stock markets worldwide. Yields declined on government bonds—both unindexed and CPI-indexed—by up to 30 basis points. The decline in government bond yields was in line with the worldwide trend. The yield differential between 10-year Israeli government bonds and equivalent 10-year US Treasury securities declined by 7 basis points, to 249 basis points. Makam yields also declined along most of the curve, by up to 30 basis points, with one-year yields declining to 1.84 percent during the period. Israel's sovereign risk premium as measured by the five-year CDS spread declined slightly this month to 145 basis points, displaying volatility during the period in light of the security related developments in Israel. The Tel-Bond 20 Index and the Tel-Bond 40 Index each increased by 0.7 percent.
The money supply: In the twelve months ending in October, the M1 monetary aggregate (cash held by the public and demand deposits) increased by 4.4 percent, and the M2 aggregate (M1 plus unindexed deposits of up to one year) increased by 4.8 percent.
Developments in the credit markets: The outstanding debt of the business sector declined by 0.7 percent in September, from NIS 792 billion to NIS 787 billion; in the past 12 months the debt has increased by 2.1 percent. Total outstanding credit to households increased in September by 0.6 percent, to NIS 383 billion. The total volume of new mortgages granted in October was NIS 3.4 billion, compared with NIS 3.2 billion in September. The balance of housing debt was NIS 274 billion at the end of September, an increase of 6.6 percent since September of 2011. Interest rates on new mortgages granted in October remained essentially unchanged. Last month, the Supervisor of Banks published a draft directive limiting the loan-to-value ratio in housing loans.
The housing market: The housing component of the CPI (representing rents) declined by 0.8 percent in October. In the twelve months ending in October it increased by 2.2 percent, compared with an increase of 2.8 percent in the twelve months to September. Home prices, which are published in the Central Bureau of Statistics survey of home prices but are not included in the CPI, increased in August–September by 0.5 percent, after increasing by 0.6 percent in July–August. In the twelve months ending in September, home prices increased by 2.2 percent, compared with an increase of 1.4 percent in the twelve months to August.
Activity in the construction industry is strong compared with its levels in the past decade. The number of building starts remains high and is expected to continue to be reflected in an increased stock of homes. At the same time, the level of building starts remains below the record level of mid–2011, and there is a decline in the rate of properties marketed by the Israel Land Administration.
The global economy: The main factor affecting global financial markets during the past month was the increased concern over budget problems (the "fiscal cliff") in the US. Economic indicators point to moderate improvement in the US and Chinese economies, in contrast to continued recession in Europe, and a deterioration in the economic situation in Japan. In Europe, it appears that the recession is reaching the core eurozone economies; in Germany there was a slowdown in real economic activity. The European Commission's updated growth forecasts for eurozone countries strengthen the pessimistic assessments in terms of a continuing slowdown in those economies next year as well. Concern over the debt crisis in Greece rose again, with the IMF and EU authorities yet to approve the next tranche of the aid package to Greece. Stock market indices world wide recorded losses for the most part this month. Yields fell on major government bond markets. Inflation rates in leading economies continued to moderate. Commodity prices remained virtually unchanged and oil prices increased slightly.
The main considerations behind the decision
The decision to leave the interest rate for December 2012 unchanged at 2 percent, after reducing it the previous month, is consistent with the Bank of Israel's interest rate policy which is intended to entrench the inflation rate within the price stability target of 1–3 percent a year over the next twelve months, and to support growth while maintaining financial stability. The path of the interest rate in the future depends on developments in the inflation environment, growth in Israel, the global economy, monetary policies of major central banks, and developments in the exchange rate of the shekel.
The following are the main considerations underlying the decision:
· The rate of inflation over the previous twelve months is at the midpoint of the inflation target range, and inflationary pressures are not visible. Various measures of inflation expectations for the coming twelve months are also around the midpoint of the target range.
· Most economic indicators which became available this month support the assessment that moderate growth in activity has continued, and is expected to continue in the coming months. These indicators are consistent with the Research Department forecast of 3.3 percent GDP growth in 2012 and 3 percent growth in 2013. Various surveys of economic activity continue to indicate pessimism and projections for moderation in activity.
· The level of economic risk from around the world remains high, and with it the concerns over negative effects on the local economy. Economic indicators point to moderate improvement in the US and Chinese economies, in contrast to continued recession in Europe and a deterioration in the economic situation in Japan. Inflation worldwide continues to be low, and commodity prices, which remained stable this month, are expected to continue to support the current level of inflation.
· During the month, most economies did not see a change in monetary policy, and interest rates in major economies remained low. In addition, markets are not pricing in an interest rate increase this year by any of the central banks of the large advanced economies. The quantitative easing policies of the Federal Reserve, the Bank of England, and the Bank of Japan continue.
The Bank of Israel will continue to monitor developments in the Israeli and global economies and in financial markets, particularly in light of the continuing high level of uncertainty in the global economy. The Bank will use the tools available to it to achieve its objectives of price stability, the encouragement of employment and growth, and support for the stability of the financial system, and in this regard will keep a close watch on developments in the asset markets, including the housing market.
The minutes of the discussions prior to the above interest rate decision will be published on December 10, 2012.
The decision regarding the interest rate for January 2013 will be published at 17:30 on Monday, December 24, 2012.