The global growth rate and inflation continue to moderate, and forecasts for them were again revised downward. In view of this, and in view of the increasing tension trade relations, the major central banks halted the trend of reducing monetary accommodation that was typical in 2018. The yield to maturity on US government bonds, particularly long-term bonds, declined during the first half of 2019, and the slope of the curve, which the economic literature considers to be a leading indicator of the business cycle, became negative during the period. From the standpoint of global risks, the high global debt levels and the decline in the quality of the debt remain the major risks to financial stability of the global economy. As such, in a scenario of a wave of declines in credit quality ratings as a result of the realization of the risks, the decline in financial asset prices around the world will be sharp and will lead to a significant tightening of the global financial environment.
In our assessment, a sharp tightening of this kind may also have an impact on the Israeli market. This effect, if it takes place, will be felt mainly through the financial channel, particularly due to the high correlation between the capital markets in Israel and abroad, and it may have significant ramifications on financial asset prices in Israel, and on the decline in the desire to take financial risks. Therefore, the potential for contagion through the financial markets remains significant. Liquidity risks in Israel increased in view of the declines in trading volumes on the stock market during the reviewed period, volumes that are low by international comparison, and in view of the high weight of holdings of corporate bonds by mutual funds and other liquid funds, with an increase in passive investments and in the activity of trading robots on the stock exchange. Should a global crisis develop, all these may increase the intensity of the declines in asset prices. In addition, the volume of global investments in Israeli companies (private capital funds in Israel) and particularly in the communications and computer services industry, is also a channel for exposure to global risks.
The overall government deficit increased at the end of 2018 and the beginning of 2019, reaching 3.8 percent of GDP, and exceeding the target set by the government. This significant increase developed in view of the structural deficit created in recent years, due to tax reductions and increased civilian expenditure. This development, which was concealed due to significant one-off revenues between 2015 and 2017, may deepen the government deficit and increase the government's credit risk, should it continue. It should be remembered that the interest paid by the government on its debt is benchmark interest for all debt payments in the private sector.
The slight declines in home prices in Israel moderated during the reviewed period, and toward the end of the period, price increases resumed alongside a continued decline in investments in construction. The stability in home prices over the past two years, alongside a continued increase in rental prices and other indicators presented in the Financial Stability Report, slightly mitigate the concern of price developments disconnected from fundamental factors. Based on all the considerations, our assessment is that the risks due to a sharp fall in home prices declined to the medium-to-low level. In order for the low likelihood of a shock in this market to persist in the long term, it is important to maintain an investment level that will respond to the volume of demand and avoid the resumption of upward pressure on home prices.
The continued growth in the credit market share of the real estate and construction industry (both for the business sector and for households) during the reviewed period, a share which is high by international comparison, kept risk in the credit market at a medium-high level during the reviewed period. The size of this market segment increases the likelihood that, if the industry encounters difficulties, it will impact the entire economy. The removal of the regulatory restriction on credit to companies in the construction industry enabled them to increase their leverage and to thereby cope with the slowdown in sales during the reviewed period.
The three lowest quintiles in the distribution of housing loans to households in Israel have been increasing their share over the years compared with the highest quintile, the latter having declined from 30 percent in 2010 to 18 percent in 2017. The diversion of housing credit from those with high incomes to those with lower incomes apparently developed due to various housing plans aimed at lower-income households, together with plans to remove investors from the housing market. While this phenomenon has positive social implications in that households in the lower deciles are receiving more housing credit than in the past, we must be vigilant to the fact that this increases the risk in the housing credit portfolio. In addition to these developments, the continued rapid expansion of noninstitutional credit and the changes in the legal environment in which credit providers in Israel are operating may increase credit risk in the long term.
The adoption of global regulations—Basel III for the banks and Solvency II for the insurance companies—as part of which the capital of the banks, particularly the largest among them, increased, strengthened the resilience of the financial institutions—both banks and institutional investors—over the years. The measures taken in recent years to limit the risks derived from the mortgage market, which is a main factor in the concentration of the credit in the real estate and construction industry, also contribute to the financial system's stronger resilience against shocks in this market. In addition, most of the banks in Israel, as abroad, issued CoCo bonds during the reviewed period. These are bonds with a loss-absorption mechanism that strengthens the stability of the issuing bank. These bonds contribute to the financial institutions' resilience against excessive losses or a sharp decline in liquidity, but they also intensify the interconnectedness in the financial system, which reflects the potential contagion among the various financial entities, which may lead to systemic crises. According to various estimates, some of which are presented in detail in the Report, our assessment is that the level of interconnectedness in the economy is not high.
Economic activity, particularly in the private sector (businesses and households), is supported by the financial system, which efficiently intermediates between borrowers and lenders. Following the most recent financial crisis, the link between the real cycle and the financial cycle has become much clearer. The empirical literature dealing with this new area of the financial cycle emphasizes the mutual relationship between the financial cycle and the real cycle, and shows that a slowdown in real economic activity is more serious when it is paired with a slowdown in financial activity. As such, identifying the location in both the financial and real cycles will provide additional information that is important for maintaining price stability and reducing the intensity of the real cycles for monetary and macroprudential policy makers. This report outlines the financial cycle in Israel in a separate box, and explains its importance for monetary and macroprudential policy. According to developments in the credit market and in home prices—two factors that impact the financial cycle—it seems that following the positive and expanding direction of in the past 12 years, the financial cycle has moderated recently.