​To view this message as Word doc


Background conditions


Inflation data: The Consumer Price Index (CPI) for March increased by 0.2 percent, and for April it increased by 0.4 percent—both months in line with forecasts. Over the past 12 months, the CPI increased by 0.8 percent, below the lower bound of the inflation target range. The main factors contributing toward a decline in the CPI in the past year were the appreciation of the shekel, declines in energy and cellular communications prices, and expansion of the Free Education Law to children from the age of three. In contrast, the main contributions to an increase in the CPI over the past year were prices of food and housing, and increased taxation and electricity prices.

Inflation and interest rate forecasts: Inflation expectations from various sources were around 1.7 percent at the time (two weeks ago) of the unscheduled Monetary Committee decision to reduce the interest rate and implement a plan to purchase foreign exchange in order offset the effect of gas production. After the Committee’s decision and the April CPI were published, inflation expectations from the various sources increased slightly, and are now slightly below the midpoint of the target range. Inflation expectations for terms of 2 years and longer (monthly averages) range from 2.3 percent to 2.5 percent. The expected increases in VAT and in electricity prices are expected to lead to higher prices in coming months, though the recent declines in prices of commodities and energy are expected to act to lower prices. Expectations for the Bank of Israel interest rate one year from now derived from various sources range between 1.3 percent and 1.45 percent.

Real economic activity: Updated indicators of economic activity which have become available so far indicate continued moderate growth in the first quarter, and a mixed trend in April. Based on National Accounts data, the GDP growth rate in the first quarter of 2013 was similar to the average growth rate over the previous 4 quarters, about 2.8 percent in annual terms. Growth in goods and services exports and in private consumption expenditure contributed to GDP growth. Investment in the principal industries declined by 19.3 percent, continuing declines of 11.6 percent and 6.9 percent, respectively, in the previous two quarters. Exports of goods and services increased by 5.6 percent—after declines of 10 percent and 5 percent, respectively, in the previous two quarters—bringing the figure back to the level it was at in the first quarter of 2011. In contrast to National Accounts data, the Climate Indices which are derived from the Business Tendency Survey of the Central Bureau of Statistics, and the Composite State of the Economy Index of the Bank of Israel indicate an increased rate of growth compared with the previous quarter. The government’s budget plan, should it be approved by the Knesset, is expected to reduce the deficit target from 4.65 percent of GDP in 2013 to 3 percent of GDP in 2014. This decline, while regaining budgetary control, is expected to moderate the growth rate of demand.

The labor market: Labor force survey data for the first quarter indicate a continued decline in the unemployment rate with a slight increase in the employment rate. In the first quarter, the unemployment rate declined to 6.5 percent (a decline of 0.3 percentage points) and the employment rate increased to 59.5 percent (an increase of 0.1 percentage points). The number of employed persons increased in the first quarter by 0.7 percent compared with the final quarter of 2012. It appears that in the past year the employment rate has stabilized at a high level, after increasing rapidly in the previous two years. The stability in employment in the past two months is reflected as well in the number of employee posts, which remained unchanged in the private sector in February, while the number of posts in the government sector increased by 0.3 percent. Nominal wages declined by 0.1 percent, and real wages declined by 0.4 percent, in January–February compared with the fourth quarter of 2012, based on seasonally adjusted data. Health tax receipts by the National Insurance Institute, which provide an indication of nominal wage payments, were 4.4 percent higher in March–April than in the corresponding period of the previous year, reflecting a slowdown in the growth of wages compared with the preceding 2 month period, when there was an average year over year increase of 5.7 percent.
Budget data: In April, the government continued to operate without an approved budget framework and in accordance with the law allowing it to spend 1/12 of the overall 2012 budget each month in 2013 (including debt repayments), until a budget framework is approved. On May 5, 2013, the government approved increased expenditure in 2013 of about NIS 6.5 billion more than that derived from the fiscal rule, as well as an increased deficit ceiling, to 4.65 percent of GDP. Cumulative tax receipts for the year to date are about NIS 2.5 billion below the seasonal path consistent with revenue projections. In April, the domestic deficit was about NIS 2.5 billion, about NIS 0.7 billion lower than the seasonal path consistent with achieving the new deficit target. The cumulative deficit from the beginning of the year is about NIS 5.7 billion, about NIS 0.4 billion lower than the seasonal path consistent with the deficit ceiling of 4.65 percent of GDP.

The foreign exchange market: From the monetary policy discussion on March 24, 2013, through the unscheduled discussion on May 12, 2013, the shekel appreciated by about 2.9 percent against the dollar and by 2.2 percent against the euro. In terms of the nominal effective exchange rate, the shekel appreciated by about 2.8 percent during the period. Since that date, the shekel has weakened by about 3.9 percent against the dollar, by 3.5 percent against the euro, and by 3.2 percent in terms of the nominal effective exchange rate. Since May 12, most currencies weakened against the dollar, though most of them by less than the shekel.

The capital and money markets: From March 24, 2013, through May 24, 2013, the Tel Aviv 25 Index declined by 2percent. Yields on government bonds declined sharply, and the yield differential between 10-year Israeli government bonds and equivalent 10-year US Treasury securities contracted by about 60 basis points, to 150 basis points. Makam yields declined along the entire curve, with declines of up to 20 basis points since the announcement of the interest rate reduction. One-year yields declined to 1.32 percent during the period. Israel's sovereign risk premium as measured by the five-year CDS spread declined during the period from 121 basis points to 100 basis points, but increased again this month to 116 basis points. The Tel-Bond 60 Index increased markedly by about 3.2 percent over the period. Spreads in the corporate bond market narrowed, primarily for debt issued by companies with lower ratings.

The money supply: In the twelve months ending in April, the M1 monetary aggregate (cash held by the public and demand deposits) increased by 8.9 percent, and the M2 aggregate (M1 plus unindexed deposits of up to one year) increased by 6.7 percent.

Developments in the credit markets: The shekel’s appreciation was the main factor in the 0.9 percent decline of business sector debt in March, to NIS 778 billion. Bond issuance by the nonfinancial private sector in March–April averaged NIS 1.7 billion per month, compared with NIS 3.3 billion, on average, in the first two months of the year. Total outstanding credit to households increased in March by 1 percent compared with February, to NIS 389 billion. The balance of credit for housing continued to increase, to NIS 274 billion in March, an increase of 0.8 percent compared with February.
The total volume of new mortgages granted was NIS 3.8 billion in March and NIS 4.1 billion in April, similar to levels in recent months of about NIS 4 billion per month. Interest rates on new fixed rate, CPI-indexed mortgages declined in April, while the interest rate on variable rate mortgages remained stable. It appears that the Banking Supervision Department’s directives had an effect on purchasers of homes for investment. The rate of mortgages granted to investment home purchasers with high LTV ratios (60–90 percent) declined from about 37 percent in November 2012 to around 9.5 percent in March 2013. Likewise, the size of the average mortgage taken out for purchasing an investment home declined during the same period by 20 percent, compared with stability in the average size of mortgages overall.
 
The housing market: The housing component of the CPI (based on housing rents) increased by 0.9 percent in April, continuing an increase of 0.8 percent in March. In the twelve months ending in April, this component increased by 3 percent, compared with an increase of 2.9 percent in the twelve months ending in March. Home prices, which are published in the Central Bureau of Statistics survey of home prices but are not included in the CPI, increased in February–March by 0.5 percent, continuing an increase of 1.4 percent in January–February. The rate of increase in home prices continues to rise. In the twelve months ending in March, home prices increased by 10.5 percent, compared with an increase of 10.1 percent in the twelve months to February.
 
There were 39,330 building starts in the 12 months ending in February, and this is expected to continue to support a high level of stock of homes. At the same time, this is still lower than the rate in 2011.
 
The global economy: The global economy continued to present a mixed macroeconomic picture in the past two months. Macro data published recently in the US were mostly positive and indicated a moderate improvement. In the eurozone, data indicated deepening recession, while in China, the data pointed toward a more significant than expected slowdown. In April, the IMF revised its 2013 growth forecast downward for most major economies. Projections were lowered by 0.2 percentage points for the global economy, to 3.3 percent, for the US economy, to 1.9 percent, and for the eurozone, to -0.3 percent. The growth forecast for China was reduced by 0.1 percentage points, to 8 percent. According to the IMF, the main risk remains the situation in Europe, with improvement there expected to be slow, as it continues to suffer from restraining budgetary policy and from a low supply of bank credit. The medium term risks include recession in Europe, fiscal crisis in Japan, and slower than expected growth in developing economies. Against the background of the economic picture, many central banks continued accommodative monetary policy—quantitative easing plans continue in the US, the ECB reduced its interest rate to a record low of 0.5 percent as the bank’s president noted that he does not rule out a further interest rate reduction, and the Bank of Japan announced at the beginning of April that it would double the rate of its planned bond purchases (a step which reinforced the weakness of the yen and apparently led other central banks to reduce the interest rate and intervene in foreign exchange markets). Inflation in major economies declined.
 
 
The main considerations behind the decision


The decision to reduce the interest rate for June 2013 by 0.25 percentage points, to 1.25 percent, 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 and in the global economy, the monetary policies of major central banks, and developments in the exchange rate of the shekel.


The following are the main considerations underlying the decision:
 
  •  Following on the measures announced by the Monetary Committee two weeks ago, the Committee decided to reduce the interest rate and thus narrow the gaps between the Bank of Israel’s interest rate and the rates in major economies worldwide, in order to weaken the forces for appreciation of the shekel.
  • During the past two months, the accommodative monetary policy of major central banks has continued, and has even accelerated in the past month. The ECB reduced its interest rate to a record low of 0.5 percent and its president stated that he does not rule out further interest rate reductions. Quantitative easing plans continue in the US, and the Bank of Japan announced at the beginning of April that it would double the rate of its bond purchase plan. The expansionary policy of central banks in major advanced economies is expected to continue, according to their announcements, in the coming year as well.
  •  The inflation environment reflected by increases in actual prices, and by inflation expectations, is moderate. In the past 12 months the CPI increased by 0.8 percent, below the lower bound of the inflation target range. Inflation expectations for the coming year, based on various sources, are slightly below the midpoint of the inflation target.
  •  Updated indicators of economic activity which have become available so far indicate continued moderate growth in the first quarter, and a mixed trend in April. Climate Indices derived from the Business Tendency Survey of the Central Bureau of Statistics, and the Composite State of the Economy Index, indicate an increased rate of growth compared with the previous quarter. In contrast, the government’s budget plan sets the deficit target for 2013 at 4.65 percent of GDP, and will reduce it in 2014 to 3 percent of GDP. This decline is expected to moderate the rate of expansion of demand.
  •  Macroeconomic data that were published for major economies worldwide were mixed. The moderate recovery in the US economy and the slowdown in Europe continue. In April, the IMF revised downward its 2013 growth forecast for most major economies.
  •  The rate of home price increases continues to rise, and in the 12 months ending in March home prices increased by 10.5 percent. Implementation of the taxation measures in the housing sector, which were approved by the government, is expected to moderate demand in the housing market.
 
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 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 interest rate decision for June 2013 will be published on June 10, 2013.
The decision regarding the interest rate for July2013 will be published at 17:30 on Monday, June 24, 2013.