This report surveys the monetary policy during the first half of 2022 and the beginning of the second half of the year.[1] In this period, the inflation rate rose above the upper bound of the target. Rising prices reflected growing global demand, continued disruptions in supply chains, and the war in Ukraine, among other factors. All of these led to an increase in energy and commodity prices around the world and accelerated inflation in Israel. Domestic demand also increased in this period, and contributed to rising inflation, especially in nontradable items.
At the same time, economic activity continued at a level that corresponded to the pre-crisis trend. The beginning of the second half of the year was characterized by a significant wave of infection, which led to an unprecedented number of individuals who tested positive for COVID-19 and were in isolation, as well as a significant rise in the number of hospitalized individuals. Nonetheless, despite the exceptional scope of contagion, and by virtue of high vaccination rates, this wave of morbidity was not accompanied by a lockdown and, with the exception of the tourism and leisure sectors, did not adversely affect economic activity.
Monetary policy: Of the interest decisions made in the first half of 2022, in three decisions the Monetary Committee decided to raise the interest rate by 1.15 percentage points, from 0.1 percent at the beginning of 2022 to 1.25 percent. These decisions followed the intervention that commenced in the previous year, which included actions to pursue a contractionary monetary policy. In this contractionary process, the Bank of Israel ended its program of bond purchases and use of other special tools that were implemented during the COVID-19 crisis. In addition, there were no foreign exchange purchases.
Inflationary environment: The first half of 2022 was characterized by a high inflationary environment relative to previous years, against the backdrop of rising energy and commodity prices around the world following the outbreak of the war in Ukraine and rising morbidity in China, and other factors. In the beginning of the reviewed half year, year over year inflation rate rose above the upper bound of the target and reached 4.1 percent in May, the highest rate in the past 10 years. Nonetheless, the rate of inflation in Israel was significantly lower than the rate of inflation in the majority of advanced economies. One-year inflation expectations in Israel and those for medium terms (two and three years) are also above the target, but expectations for the longer term are anchored within the target range.
Domestic real activity: The data and indicators presented to the Monetary Committee in the first half of 2022 indicated that the Israeli economy maintained continuous economic activity at a level that corresponded with the trend that preceded the COVID-19 crisis. That high level of economic activity was maintained even during the wave of Omicron infection, due to factors that included the adjustment of most economic industries to activity alongside the pandemic. The pandemic’s effect on economic activity almost completely dissipated in the first half of this year, and the tourism sector recorded considerable recovery. High levels of activity clearly characterized all areas of economic activity, although following the exceptional growth in the final quarter of 2021, GDP contracted slightly in the first quarter of 2022 and stabilized close to its pre-crisis trend. The decline in GDP in this period was recorded in most major uses and effectively reflected a mirror image of the spurt in economic activity in the previous quarter. At the same time, the first half of the year was also characterized by significant uncertainty in view of global geopolitical developments, political uncertainty, and security incidents in Israel.
The labor market: Employment and job vacancy data show that the labor market is tight, which is expressed in a low unemployment rate alongside a high job vacancy rate. In the reviewed half year, the employment rate hovered around the pre-crisis level and unemployment dropped to a level slightly lower than its pre-crisis rate. In this period, wages in the business sector exceeded the long-term trend that prevailed in the pre-crisis period, while wages in the public sector increased at a more moderate rate.
Exchange rates: In the first half of this year, the trend reversed, and after the appreciation of the shekel that was recorded in recent years, the shekel depreciated against major currencies. No foreign exchange purchases were recorded between February and June.
The global economy: In the reviewed half year, the global economy recorded a slowdown. The war in Ukraine and the slowdown in economic activity in China as a result of rising infection and policy responses, exacerbated the disruptions in global supply chains, increased inflationary pressure, and accelerated the implementation by many central banks of a contractionary monetary policy. In view of these developments, growth forecasts in many countries were revised downward.
The global inflationary environment continued to rise; in many advanced economies inflation indices exceeded central bank targets. In the US, inflation continues to be high and at the end of the period was approximately 8.6 percent, a historical high. A rapid rise in inflation was also recorded in the eurozone, where inflation was 8.1 percent in May. In many countries, the core inflation rate also exceeded the target, yet to a smaller extent,
In view of this, many countries accelerated a retreat from the nonconventional accommodative policies adopted during the COVID-19 crisis, and embarked on a gradual rise in interest rates. In the US, the Fed increased the interest rate in June to 1.75%. In the eurozone, the ECB accelerated the pace of reduction of its purchase program, which is expected to end in the next few months. According to assessments, the ECB will begin raising interest rates later this year. Rising interest rates were also recorded in several additional countries in which inflation is above central bank targets.
The credit market: Despite the increase in the interest rate environment, credit to the business sector continues to expand. Especially prominent was the rapid expansion of credit to the construction and real estate sectors. Credit constraints for companies are low in all sectors. The increase in new mortgage volume, which was recorded in the early months of the year, halted toward the end of the reviewed half year. In this period, new mortgages were characterized by some rise in risk measures, including an increase in LTV (the loan to value ratio), PTI (the payment to income ratio), and value of purchased properties.
Developments in the financial markets: The reviewed half year opened with sharp drops in both the domestic and global financial markets, after a year of impressive increasing prices and large volumes of capital raised. Assessments from the Telbor market with respect to expectations of the future path of the Bank of Israel interest rate increased during the course of the reviewed half year. At the end of this period one-year expectations reached 3.2 percent.
Fiscal policy: In the reviewed half year, domestic revenues increased and exceeded expectations based on various forecasts. The increase in direct tax collection is attributed mainly to collection of taxes from companies and self-employed individuals (including company shareholders) and from land taxes. Indirect taxes also recorded a considerable real increase. Health tax, which reflects total wage payments, continues to hover around the trend. Government expenditure also declined in this period, mainly in view of the steps to reduce expenses in order to cope with the COVID-19 crisis. As a result of all these factors, the deficit also declined.
The housing market: Rising housing prices continued to intensify in the reviewed half year. As of March, apartment prices rose by 15.4 percent in annual terms. Alongside this development, the housing component in the CPI continued to increase at a relatively moderate rate (3.7 percent, as of May).
The Research Department forecast: The Research Department published three forecasts in the reviewed half year, simultaneously with interest rate announcements in January, April, and July, 2022. According to the July forecast, GDP will grow by 5.0 percent in 2022, which is lower than the January and April forecasts (5.5 percent). According to the July forecast, the unemployment rate is expected to decline to a level of about 3.3 percent at the end of 2022 (3.5 percent according to the April forecast). In 2023, growth is expected to be 3.5 percent (4.0 percent according to the April forecast). The debt to GDP ratio is expected to be 66 percent in 2022 and 64 percent in 2023 (67 percent and 65 percent, respectively, according to the April forecast). Inflation during the next four quarters (which end in the second quarter of 2023) is expected to be 3.3 percent. Inflation rates expected for the years 2022 and 2023 were revised upward and are 4.5 percent and 2.4 percent, respectively. The Research Department expects that the average interest rate in the second quarter of 2023 will be 2.75 percent.
[1] In 2022, decisions were made on January 3, February 21, April 11, May 23, and July 4, 2022.