Staff Forecast

Background conditions

Inflation data: The Consumer Price Index (CPI) for November declined by 0.2 percent, in line with forecasters’ projections. The clothing and footwear component increased markedly, while the fruit and vegetables, and transport and communication components declined notably. The inflation rate over the past 12 months was negative 0.1 percent, compared with negative 0.3 percent over the 12 months ended in October. The tradable goods components of the CPI declined by 0.4 percent this month, and their rate of decline over the past 12 months remained unchanged from the previous month, at 1.8 percent. The CPI components representing nontradable items declined by 0.1 percent this month; their rate of increase over the previous 12 months increased to 0.9 percent, compared with 0.6 percent in the 12 months ending in October. Over the past 12 months, there have been marked declines in the food, fruit and vegetables, and furniture and household equipment components, with only the housing component increasing significantly.

Inflation and interest rate forecasts: The declines in water and electricity prices that are planned for the beginning of January are expected to reduce the inflation rate by about 0.4 percent, in a one-off effect. Against this background, inflation expectations derived from various sources remain low. Inflation expectations derived from the capital market were volatile during the month, due to fluctuations in government bond yields, and at the end of the period, one-year inflation expectations (seasonally adjusted) were 0.45 percent, and expectations for two years were 0.8 percent. Private forecasters’ projections for the next 12 CPI readings declined from 0.7 percent to 0.6 percent, on average. Expectations for the coming 12 CPI readings derived from banks’ internal interest rates declined from 0.4 percent to 0.3 percent. Expectations for medium and long terms were also volatile during the month, and showed slight increases at the end of the period. Based on private forecasters’ projections, and data derived from the makam and Telbor curves, no change is expected in the Bank of Israel interest rate in the next three months.

Real economic activity: Indicators that became available this month continue to point to a recovery in economic activity after Operation Protective Edge, though the conflict’s negative impact on the economy and on growth has not yet been fully compensated for. Foreign trade data declined this month (in dollar terms; due to the strengthening of the dollar worldwide it may be assumed that the quantitative decline was smaller). Goods exports (excluding ships and aircraft and diamonds) declined by 3.0 percent in November, compared with October, after increasing in the previous two months. Goods imports (excluding ships and aircraft, diamonds and fuels) declined by 1.5 percent, further to the marked decline in October. Exports of other business services (excluding start-ups) remained unchanged at the peak levels they reached at the beginning of the year. Data on tourist arrivals and overnight stays indicate some recovery in the tourism industry, and it is occurring at a relatively rapid rate compared with that following previous security incidents. However, tourism service exports, and with them agricultural exports, to Russia constitute a marked share of overall tourism service and agricultural exports—even though total exports to Russia are only a small share of Israel’s total exports—so these industries are therefore liable to be negatively impacted by the crisis there. The Composite State of the Economy Index increased by 0.1 percent in November, similar to its pace of increase since the beginning of the year. Preliminary data from the Bank of Israel’s Companies Survey for the fourth quarter point to improvement in the state of companies and a return of activity to its level at the beginning of 2014. The business sector Climate Index, based on the Business Tendency Survey conducted by the Central Bureau of Statistics for November, continues to indicate a relatively low monthly growth rate, of 0.17 percent. The Consumer Confidence Index compiled by Bank Hapoalim continued to decline this month, returning to its level at the beginning of 2014. The Consumer Confidence Index compiled by the Central Bureau of Statistics has remained virtually unchanged since July. Bank Hapoalim’s Purchasing Managers Index increased slightly in November, to 48.7 points, and remains below the level that distinguishes between contraction and expansion.

 

The labor market: Labor market data that became available this month bolster the positive picture emerging from that market. The Labor Force Survey for November indicates an increase in both the employment and participation rates among the primary working ages (25–64) by 0.6 percentage points, with the unemployment rate remaining low at 4.8 percent. The overall unemployment rate declined by 0.1 percentage points to 5.6 percent. In parallel, the number of those employed full-time increased in August–November by 4.2 percent, and the number of those employed on a part-time basis declined by 1.4 percent. The number of employee posts rose by 0.7 percent in September, compared to August, with the increase occurring in both the business sector and in the public services. Nominal wages increased in July–September by 1.0 percent, and real wages increased by 0.9 percent, compared to April–June (seasonally adjusted data). Health tax receipts continued to increase at a stable rate, and were 5.4 percent higher (in nominal terms) in October–November than the corresponding period last year.
 
Budget data: In January­–November, the deficit in the government’s domestic activity (excluding net credit) was about NIS 9.6 billion. This is about NIS 4.9 billion smaller than the deficit in the seasonal path consistent with meeting the 2014 deficit target, as expenditure has been lower than the seasonal path consistent with full budget performance. Total domestic expenditures (excluding credit) were NIS 6.6 billion lower in January–November than the expenditure consistent with the seasonal path. With that, expenditure is expected to accelerate in December and reach full budget performance for 2014, due to, among other things, the defense supplement. Domestic revenues from the beginning of the year are about NIS 1.7 billion lower than the seasonal path consistent with the budget forecast. Based on trend data, tax revenue in November, excluding one-time effects, remained without significant change compared to previous months. The transition to a 1/12 budget will not restrict budget performance in most months during 2015 compared with the budget proposal that was approved by the government, since the redemption of debts expected in 2015 is smaller than in 2014. With that, there will be a limitation on expenditures for new programs.

 

Research Department staff forecast: This month the Research Department updated its macroeconomic forecast. The notice of the forecast is being published in parallel with this release. According to the revised forecast, the inflation rate in 2015 will be 1.1 percent (1.5 percent excluding the effect of the decline in electricity and water prices); the Bank of Israel interest rate is expected, according to the staff forecast, to remain at 0.25 percent throughout 2015 and to increase slowly in 2016. GDP is expected to grow in 2014 by 2.5 percent (2.3 percent in the previous forecast), in 2015 it is expected to grow by 3.2 percent (3.0 percent in the previous forecast), and in 2016 it is expected to grow by 3.0 percent.
 
The foreign exchange market: From the monetary policy discussion on November 24, 2014, through December 25, 2014, the shekel weakened by 2 percent against the dollar. The shekel appreciated by 0.7 percent against the euro, and by 0.2 percent in terms of the nominal effective exchange rate. For the year to date, the shekel has weakened by about 3.7 percent in terms of the effective exchange rate.
 
The capital and money markets: From the monetary policy discussion on November 24, 2014, through December 25, 2014, the Tel Aviv 25 Index increased by about 1.3 percent. Government bond yields increased, as yields on the unindexed curve increased by about 25 basis points for most terms and yields on the CPI-indexed curve increased by an average of about 15 basis points. The yield on unindexed 10-year bonds increased by around 30 basis points, to about 2.45 percent, and the yield differential between 10-year Israeli government bonds and corresponding 10-year US Treasury securities returned to a positive value and increased to about 20 basis points. Makam yields increased by about 7 basis points along the entire curve. Israel's sovereign risk premium as measured by the five-year CDS spread declined slightly, to about 77 basis points.
 
The money supply: In the twelve months ending in November, the M1 monetary aggregate (cash held by the public and demand deposits) increased by 32.8 percent, and the M2 aggregate (M1 plus unindexed deposits of up to one year) increased by 8.4 percent.

 

The credit market: Total outstanding debt of the business sector declined by about NIS 0.7 billion (0.1 percent) in October, to NIS 817 billion, primarily as a result of net repayment of bank loans which was partly offset by the depreciation of the shekel. In November, the nonfinancial business sector only issued about NIS 0.9 billion in bonds, compared with a monthly average of NIS 2.7 billion since the beginning of the year. After negative net new investment by the public in corporate bond mutual funds in recent months, there were extensive withdrawals from such funds as well as from general bond funds in December, with a slight increase in corporate bond market spreads, primarily in the investment and holding companies sector. Outstanding household debt increased by about NIS 3.1 billion (0.7 percent) in October, to about NIS 431 billion. Of that, outstanding housing debt increased by about NIS 1 billion. In November, about NIS 4 billion in new mortgages were taken out, compared with a monthly average of about NIS 4.2 billion since the beginning of the year. The interest rate on new mortgages taken out declined in November on all tracks, with the decline most notable in the unindexed, fixed-rate, track.

 

The housing market: The housing component of the CPI (based on residential rents) increased by 0.2 percent in November, similar to the previous month. In the 12 months that ended in November, this component increased by 2.7 percent. After declines in home prices reported in the previous two months’ data, in September-October, still before the announcement of the cancellation of the zero-VAT plan, they increased sharply, by 1.4 percent. The trend of decline in the annual rate of increase in home prices halted, with prices increasing by 6.5 percent over the 12 months ending in October, compared with an increase of 4.6 percent in the 12 months ended in September. The increase in the number of new home sales continued in October, after a sharp increase in September. There was no change in the number of new homes available for sale. The first tenders in the target-pricing program commenced this month. In the third quarter, there were sharp increases in building starts and building completions, and in the past 12 months they totaled 44,200 and 42,100, respectively.
 
The global economy: The divergent trends in the global economy continued this month, with strong growth in the US and weakness in Europe, Japan, and emerging economies. The decline in fuel prices is expected to support the global economy. However, as occurred in Russia, it is liable to negatively impact the economic stability of oil exporters. In the US, third quarter growth was again revised upward. In the labor market, US nonfarm payrolls increased by around 320,000 in November, and industrial production reached its highest level since 2010. In contrast, weakness is apparent in the real estate industry, and purchasing managers indices were mostly disappointing. There is some moderation in inflation, in light of the decline in energy prices, and financial markets are pricing in a first increase in the federal funds rate in the third quarter of 2015. In Europe, the fragile and uneven recovery continues, with the unemployment rate remaining above 11 percent. In France and Italy, weak data were published this month, while in Germany slightly better data were published. The eurozone’s Current Account surprised to the upside, against the background of the weakening of the euro, and there is an increasing probability that the ECB will launch a significant quantitative easing program in 2015. In Switzerland, a negative interest rate was set for deposits at the central bank, against the background of strengthening appreciation pressures, and in Norway the interest rate was reduced due to the expected negative impact on the economy of the decline in oil prices. In Japan, a reduction in corporate taxes and a deferral of an increase in the VAT rate following election results are expected to support recovery, but in contrast they will increase fiscal risk. Disappointing macro data were published in China this month, and inflation there is moderating against the background of the decline in oil prices. In Brazil, the virtual standstill continues, and nonetheless the interest rate was increased due to high inflation. In India, positive trends continue, and the recovery is expected to continue. In recent days, it appears that the policy measures in Russia stabilized the situation there for now. There was a mixed trend on global financial markets this month, with an increase in volatility. Oil prices declined by more than 20 percent this month, and the price of a barrel of Brent Sea crude oil reached $60.

The main considerations behind the decision
 
The decision to keep the interest rate for January 2015 unchanged at 0.25 percent is consistent with the Bank of Israel's monetary policy, which is intended to return the inflation rate to 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:
 
  • The rate of inflation as measured over the previous 12 months was negative 0.1 percent, compared with negative 0.3 percent over the 12 months ending in October. Excluding the expected effect of a reduction in electricity and water prices, inflation expectations for the coming year from the various sources are near the lower bound of the inflation target range. According to the Research Department’s staff forecast, the inflation rate in 2015 is expected to be 1.1 percent, and net of the effect of the electricity and water price reductions it is expected to be 1.5 percent.
  • Indicators which became available this month point to a recovery in activity after Operation Protective Edge, with the economy’s expected return to its path of growth from before the operation expressed in a relatively high growth rate in the coming quarters. Partial data from the fourth quarter Companies Survey support this assessment, and the Composite State of the Economy Index continues to increase at the moderate rate that has characterized it since the beginning of the year. All labor market indicators also signal continued improvement. Based on the Research Department’s staff forecast, growth in 2015 is expected to be 3.2 percent.
  • There was considerable volatility in the foreign exchange market this month. Over the course of the month, the shekel appreciated by 0.2 percent in terms of the nominal effective exchange rate, and weakened by 2 percent against the dollar. Since the beginning of August, when the trend of depreciation in the effective exchange rate began, the shekel has weakened by 6.9 percent, and it has depreciated by about 3.7 percent since the beginning of the year. Continued depreciation will support a recovery in exports and in the tradable sector as a whole, and is expected to contribute to returning the inflation rate to within the target range.
  • There are increasing signs that the US recovery is solidifying, while weakness continues in Europe, Japan and most emerging markets. The crisis in Russia was expressed in increased volatility in global financial markets. The decline in energy prices is expected to continue to reduce global inflation and to support the economic recovery. Financial markets are pricing in an initial increase in the US federal funds rate in the third quarter of 2015; in Europe and in other economies, monetary easing continues.
  • Home prices increased sharply in September-October, even before the announcement of the cancellation of the zero-VAT plan, and it appears that there is an increase in the rate of mortgages being taken out and in new home sales. There were sharp increases in the number of building starts and building completions in the third quarter.
  • This month, there was a slight increase in corporate bond market spreads, and extensive negative net new investment in bond funds.
 
The Monetary Committee is of the opinion that the current level of the interest rate supports the continuation of the recovery in economic activity, and the return of inflation to within the target range.
 
The Bank of Israel will continue to monitor developments in the Israeli and global economies and in financial markets. The Bank will use the tools available to it and will examine the need to use various tools 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 continue to keep a close watch on developments in the asset markets, including the housing market.
 
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The minutes of the monetary discussions prior to the interest rate decision for January 2015 will be published on January 12, 2015.

The decision regarding the interest rate for February 2015 will be published at 16:00 on Monday, January 26, 2015.