Background conditions
Inflation data: The Consumer Price Index for May increased by 0.3 percent, a slightly higher increase than the average of forecasters’ predictions for an increase of 0.2 percent. There was a significant increase (4.4 percent) in the vegetables and fruit component, and there was an increase in the miscellaneous component (0.9 percent). There was no significant decline in any of the components. The inflation rate as measured by the change in the CPI over the past 12 months was -0.8 percent, compared with -0.9 percent in the 12 months ending in April. Excluding the direct effect of energy prices and administrative price reductions, inflation over the past 12 months was 0.5 percent. Prices of components representing tradable goods in the CPI declined by 3.2 percent over the past 12 months, and the prices of components representing nontradable items increased by 0.5 percent.
Inflation and interest rate forecasts: There was a slight increase in one-year inflation expectations this month, against the background of the increase in oil prices, the depreciation of the shekel, increases in wages, and continued growth of private consumption. Expectations derived from the capital market increased to 0.4 percent (compared with 0.3 percent in the previous month). Expectations for inflation over the coming 12 months derived from banks’ internal interest rates increased to 0.3 percent (compared with 0.25 percent last month), and private forecasters’ projections for the next 12 CPI readings are for an increase of 0.8 percent, on average, (compared with 0.7 percent in the previous month). Medium-term and long-term forward expectations remained stable, except for a decline of 0.2 percentage points in third-year forward expectations, to 1.1 percent. Longer term expectations remained within the target range with medium-term (3–5 years) expectations at 1.3 percent, and long-term (5–10 years) expectations at 2.2 percent. The makam curve and the Telbor curve remained unchanged, and do not indicate any change expected in the Bank of Israel interest rate in the next year. According to the average of projections by private forecasters, the Bank of Israel interest rate is expected to remain at its current level in the coming months.
Real economic activity: The second estimate of National Accounts data for the first quarter indicates growth of 1.3 percent (compared with 0.8 percent in the first estimate) in GDP, and of 0.2 percent (compared with a decline of 0.4 percent) in business product (seasonally adjusted data in annual terms). Indicators of real economic activity that became available this month point to an apparent return of the growth rate to the levels that characterized it in recent years. This assessment is supported, inter alia, by partial data from the Companies Survey for the second quarter, which indicate some increase in the net balance relative to the first quarter. According to export data, goods exports (excluding ships and aircraft and diamonds) in April–May were about 4 percent lower than the average for the first quarter. The decline in exports is concentrated in four industries that were affected by factors, some of which are not expected to persist—electronic components, chemicals, pharmaceuticals, and vehicles—which together comprise about half of goods exports. The remaining exports increased by 4.7 percent during the same period. Business services exports (excluding startups) were 3 percent higher in April than the average for the first quarter. There was a surplus of $3.3 billion (seasonally adjusted) recorded in the Current Account of the Balance of Payments, similar to the average in the past two years. The Composite State of the Economy Index increased by 0.1 percent in May, led by an increase in the consumer goods imports and in the import of manufacturing inputs. Previous index readings were revised downward. The Consumer Confidence Indices compiled by Bank Hapoalim and by the Central Bureau of Statistics declined in May, but remained higher than the average of the last year. The Purchasing Managers Index declined slightly in May, to 49.4 points.
The labor market: The picture conveyed by the labor market remains positive. Labor Force Survey data for May indicates that the unemployment rate among the prime working ages (25–64) declined to 4.1 percent, compared with 4.3 percent in April. There was a slight increase in the employment rate (to 77.1 percent, from 77.0 percent in April), and stability the participation rate (80.4 percent). The increase in wages across the economy continued. Real wages increased by 1.5 percent (seasonally adjusted) in January–March, compared with the three previous months, while nominal wages increased by 1.3 percent. Health tax receipts for March–May were 5.7 percent higher (in nominal terms) than in the corresponding period in the year before, reflecting the increase in employment and wages. The job vacancy rate was a record 3.8 percent (seasonally adjusted) in May. Stability in the number of employee posts in recent months may be a result of the transition of workers from part-time to full-time positions.
Budget data: The cumulative domestic surplus (excluding net credit) in government activity was NIS 2.3 billion in January–May 2016, compared with a surplus of approximately NIS 2.8 billion in the corresponding period of 2015, and it is about NIS 3.5 billion higher than the seasonal path consistent with achieving the deficit target for 2016. The deviation reflects revenues that were NIS 1.7 billion higher than the path, and expenditures that were NIS 1.8 billion lower than the path. Tax revenues in May were NIS 26.4 billion, which is about NIS 2 billion higher than the seasonal path consistent with the estimate of tax revenue. Tax revenues in January–May were about 6.4 percent higher in real terms than in the corresponding period of the previous year. Gross domestic VAT collection increased by about 7.2 percent in real terms compared with May of 2015 (about 13.1 percent net of the effect of legislative changes).
Staff forecast: This month, the Research Department updated its macroeconomic forecast, which reflects an initial assessment, relying on estimates by the International Monetary Fund, of the implications of the Brexit for the global economy. The notice of the forecast is being published in parallel with this release. Compared with the previous quarterly forecast, the current forecast reflects a similar assessment regarding the development of inflation, and more moderate assessments of the growth rate and the interest rate. The inflation rate is expected to be 1.0 percent over the coming four quarters and is expected to return to within the target range toward the middle of 2017. The Bank of Israel interest rate is expected to remain at 0.1 percent during the coming year, and to increase to 0.25 percent toward the end of 2017. GDP is expected to grow by 2.4 percent in 2016 (compared with 2.8 percent in the previous forecast due to the low growth in the first quarter) and by 2.9 percent in 2017 (compared with 3.0 percent in the previous forecast).
The foreign exchange market: From the monetary policy discussion on May 22, 2016, through June 24, 2016, the shekel weakened by 0.4 percent against the dollar, and remained virtually unchanged in terms of the nominal effective exchange rate—appreciation of 0.1 percent. On the trading day following the referendum in Britain, there was no significant change in the effective exchange rate, despite volatility in the cross rates. Over the preceding 12 months, the shekel appreciated by 0.1 percent in terms of the nominal effective exchange rate.
The capital and money markets: From the monetary policy discussion on May 22, 2016, through June 23, 2016, the Tel Aviv 25 Index increased by about 0.4 percent. Government bond yields declined slightly along the nominal curve, and increased slightly along the indexed curve. The makam curve traded at a yield ranging around the Bank of Israel interest rate. Israel's sovereign risk premium, as measured by the five-year CDS spread, increased to 85 basis points. The response of the Israeli capital market to the referendum in Britain was moderate relative to abroad. On June 25, the first trading day in Israel following the referendum, the Tel Aviv 25 index declined by 3.2 percent, and the yields on government bonds declined by 10 basis points.
The money supply: In the 12 months ending in May, the M1 monetary aggregate (cash held by the public and demand deposits) increased by 25 percent, and the M2 aggregate (M1 plus unindexed deposits of up to one year) increased by 11.3 percent.
The credit market: In May, the business sector (excluding banks and insurance companies) issued bonds totaling NIS 2.3 billion, after issuances totaled NIS 5.1 billion in April. The average of monthly issuances in the past year is about NIS 2.6 billion. The volume of mutual fund withdrawals remained high in May, totaling NIS 1.5 billion. In contrast, funds specializing in corporate bonds and in equities in Israel continued to attract net new investment. Corporate bond spreads continued to decline in most industries, and were about 3.4 percentage points, on average (excluding bonds of financial corporations). In May, the total volume of new mortgages taken out was NIS 5.3 billion, similar to the average of the past 12 months, even though May is typically characterized by a high level of new mortgages taken out. The rate of mortgages issued for the purchase of investment homes was 13.5 percent in May, compared to an average of 15 percent in the past 12 months. The interest rate on mortgages in the variable-rate unindexed track, the variable-rate CPI-indexed track and the fixed-rate unindexed track increased by 0.01–0.04 percentage points, while the interest rate on the fixed-rate CPI-indexed track declined by 0.07 percentage points.
The housing market: The housing component of the CPI (based on residential rents) remained unchanged in May, after increasing by 0.2 percent in April. The rate of home prices increases remains high. Home prices increased by 1.2 percent in March–April, and by 7.8 percent in the 12 months ending in April, compared with 7.2 percent in the 12 months ending in March. Activity in the market remains robust, with 7,700 transactions carried out in April, slightly lower than the annual average of 8,100 transactions per months. The volume of new-home sales was about 2,600 in April, similar to the monthly average over the past year. The stock of new homes available for sale increased in April to approximately 27,400 homes, the highest level since the end of 2014. During the past year, there has been an apparent decline in the number of building starts and the duration of construction has become longer. However, the annual rate of building starts remains high—about 47,000 in the past four quarters.
The global economy: The results of the referendum in the UK surprised the financial markets, and led to a high level of volatility. At the end of the first trading day following the referendum, the pound sterling had weakened by 7.6 percent against the US dollar and the euro weakened by 2.1 percent against the dollar, while the Japanese yen strengthened by 3.4 percent against the dollar. Share indices declined by up to about 13 percent (with sharp declines in bank shares), and yields on 10-year government bonds declined by up to about 30 basis points. At this stage, it is too early to assess whether the volatility will continue in the coming days. According to International Monetary Fund assessments published prior to the referendum, the effect of Britain leaving the EU is expected to result in a negative impact of 0.1–0.3 percent of global GDP.
Data that became available this month continue to indicate a continuation of the moderation in the global economy, a trend that was focused mainly on the emerging markets. Indices of global economic activity indicated moderate growth of the services sector and a lack of growth in the manufacturing sector, as well as continued very moderate growth of world trade. The uncertainty due to the referendum in the UK led to a sharp decline in yields on government bonds considered “safe”, some of which declined to historic lows. In the US, the number of new jobs added was particularly low—about 38,000 positions—contributing to the Federal Reserve’s decision to leave the interest rate unchanged, and to a decline in the path of the expected interest rate based on forecasts by members of the FOMC. Weakness in the manufacturing sector continues, but private consumption continues to support growth. According to the GDPNow index, growth in the second quarter is expected to be 2.6 percent. Inflation remains low, but the core indices are close to 2 percent. In Europe, the estimate of first quarter growth was revised downward (0.6 percent quarterly), and macroeconomic data published during the month indicated lower growth in the second quarter. The unemployment rate remained stable at a high rate of 10.2 percent. Inflation remains negative, and core inflation is also far from the target. In Japan, weakness in economic activity continued, which led the government to delay the planned VAT increase. There, too, inflation is negative and core inflation is low. In China, economic activity continued to grow at a relatively moderate rate. The price of a barrel of oil ranged around $50 this month, and the index of commodities excluding energy increased by about 2 percent.
The main considerations behind the decision
The decision to keep the interest rate for July 2016 unchanged at 0.1 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, and to support growth while maintaining financial stability. Uncertainty regarding the implications of the Brexit, and the continued decline of exports in recent months, strengthen the Monetary Committee’s assessment that in view of developments in the inflation environment, in growth in Israel and in the global economy, in the exchange rate, as well as in monetary policies of major central banks, monetary policy will remain accommodative for a considerable time.
The following are the main considerations underlying the decision:
· In the past two months the Consumer Price Index increased, and there was a slight increase this month in one-year inflation expectations from various sources. The rapid increase in wages and continued increase in private consumption will support the return of inflation to within the target range within about a year, according to the Research Department’s staff forecast. Medium and long-term expectations remain anchored within the target range.
· The second estimate of National Accounts data for the first quarter also shows that growth was low, but the Research Department’s assessment shows that the economy has returned to the level of growth that characterized it the past few years. The decline in exports is concentrated in a number of industries that were affected by factors, some of which are not expected to persist, and private consumption continues to lead growth, supported by the low interest rate and the increase in wages. The picture emerging from the labor market remains positive, and there are signs that the economy is nearing full employment.
· The results of the referendum in Britain were a surprise, and the global financial markets reacted sharply. At this stage it is too early to assess whether the short-term effect on the financial markets has run its course. In the coming months, uncertainty is expected regarding the implications of the Brexit process for the global economy. The monetary policy of the major central banks is expected to remain very accommodative.
· From the monetary policy discussion on May 22, 2016, through June 24, 2016, the shekel weakened by 0.4 percent against the dollar, and the effective exchange rate remained virtually unchanged—appreciation of 0.1 percent. Looking at the past year, the effective exchange rate stabilized, but its level continues to pose difficulties for the growth of exports and of the tradable sector.
· The pace of home price increases remains high, and both the level of transactions and the volume of mortgages remain high.
The Monetary Committee is of the opinion that, in view of the uncertainty generated due to the Brexit, the risks to achieving the inflation target and to growth have increased. 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.
The minutes of the monetary discussions prior to the interest rate decision for July 2016 will be published on July 11, 2016.
The decision regarding the interest rate for August 2016 will be published at 16:00 on Monday, July 25, 2016.