Monetary policy: This report reviews monetary policy during the second half of 2020 and the beginning of the first half of 2021.1 During the reviewed period, against the background of the continuation of the crisis and the deterioration in economic conditions due to the spread of the coronavirus and the steps taken to prevent it, the Monetary Committee implemented several tools with the goal of dealing with the crisis. The steps taken were intended to reduce the adverse economic impact caused by the health crisis, to ensure the continued orderly functioning of the financial markets, to enhance the passthrough from the Bank of Israel interest rate to market interest rates, and to encourage demand and inflation through easing credit conditions, aided as well by the operation of specific and focused credit mechanisms.
The July decision included, for the first time, the purchase of corporate bonds in the secondary market, at a scope of NIS 15 billion. In addition, it was decided to renew the special program for expanding the supply of credit to small businesses and to create an infrastructure to expand the range of assets that banks can accept as collateral in order to extend credit. In the October decision, the Committee announced the expansion of the bond purchase program by NIS 35 billion. In addition, a new pillar was decided upon in the program to ease credit terms for small and micro businesses: the Bank of Israel will provide the banking system with loans at a negative interest rate of -0.1 percent, for the first time in Israel, in accordance with the conditions that were set. During the second half of the year, the interest rate was kept unchanged at 0.1 percent. Other than the tools noted above, the Bank of Israel continued during the half year to purchase foreign exchange. Alongside the monetary tools that the Committee implemented, the Banking Supervision Department at the Bank of Israel took several additional steps in the credit market.
Domestic real activity: The data and indicators that were presented to the Monetary Committee in the half year reviewed described the Israeli economy’s recovery during the summer months, but also the sharp negative impact on activity during the second lockdown in September-October. During the second lockdown, a sharp decline in activity was seen, but at a more moderate intensity than there had been in the first lockdown. Labor market data indicate that before the second lockdown was imposed, the broad unemployment rate was stable at around 11-12 percent; that during the lockdown it soared to about 23 percent in the first half of October; and that after the lockdown it declined gradually to about 12.7 percent in the first half of December.
The inflation environment: During the second half of 2020, the inflation environment remained low, and the year over year inflation rate was still negative, but slightly higher than at the end of the first half. Inflation in the past 12 months is -0.6 percent, and is -0.2 percent net of energy and fruit and vegetables. One-year inflation expectations from all sources declined during the half year and were below the lower bound of the target range, and expectations derived from the capital market returned to the negative range in October-November. Forward expectations for all ranges remained essentially unchanged in the second half, and expectations for medium and longer terms (more than 3 years) remained anchored within the target range throughout the half year.
The exchange rate: During most of the second half, the shekel strengthened slightly vis-à-vis the nominal effective exchange rate, and in particular – in the last two months of the half year there was significant appreciation. This was mainly due to the shekel strengthening against the dollar. At the end of the half year reviewed, the shekel-dollar exchange rate was at the low level of NIS 3.2/$.
The global economy: During the third quarter the global economy improved, against the background of the decline in the infection rate and easing of the lockdown policies, with considerable variance among economies: there was an improvement in the US, which was stronger than Japan and Europe, and China’s economy was notably good due to its success in dealing with the health crisis. The improvement in activity led as well to an upward revision of the IMF’s forecast. World trade contracted sharply, and global inflation remained low. With that, in the US it rose slightly to 1.2 percent. Monetary policy in various countries remained very accommodative, central banks continued to signal their readiness to take additional unconventional steps in order to ease financial terms. Equity indices on capital markets worldwide recovered in the half year, but volatility remains high.
Credit market: Bank credit balances of small businesses and commercial credit remained stable throughout the half year. The credit market continued to function with stable interest rates, with support from a range of steps by the Bank of Israel and the Ministry of Finance. The average interest rate for small businesses even declined slightly. Based on the Business Tendency Survey, conducted by the Central Bureau of Statistics, there is a continued trend of decline in the constraint of raising funds – bank credit as well as nonbank credit – and the indices are approaching pre-crisis levels even though they are still high compared to the pre-crisis period. The bank credit balance in respect of which payments were deferred under the framework for deferring loan payments, which was initiated by the Banking Supervision Department, is around NIS 160 billion, of which 65 percent (NIS 104 billion) are housing loans and about 13 percent (NIS 21.1 billion) was credit to micro businesses. For about 41 percent of the deferred credit balances, payments have not yet been renewed. Activity continues in the fund to provide government-guaranteed credit to small and medium sized businesses, even in the track that is at enhanced risk. The utilization rate of the fund for large companies remained relatively stable.
Financial market developments: In the first half of 2020, the spread of the coronavirus led to sharp declines in financial markets in Israel and abroad. In response, many central banks, including the Bank of Israel, continued in the second half of the year as well to operate various asset purchase programs and to remove credit barriers to groups that needed it. This was to ensure that the markets remained liquid and to support their orderly functioning. The government bond yield curve steepened slightly, alongside higher yields in the nominal (unindexed) curve, similar to the trend worldwide, led by the US. Corporate bond spreads continued to narrow, alongside some increases in equity indices, but returns including equity markets in Israel this year are markedly lower compared with the rest of the world. Financial markets maintained relative stability for most of the second half of 2020, and at the end there were price increases, among other things against the background of news regarding coronavirus vaccines.
Fiscal policy: In discussions on fiscal policy, Monetary Committee members expressed concern throughout the half year about the continued uncertainty deriving from the lack of a budget for 2020 and the nonsubmissison of a 2021 budget for government approval. The deficit reached 9.1 percent of GDP in September, and at the end of the year was expected to be about 12 percent of GDP. About three-quarters of the deficit is attributed to the ramifications of the coronavirus pandemic—half is due to increased expenditure and a quarter due to decreased tax revenues due to the response of GDP to the crisis.
The housing market: After a moderation of the rate of increase of rents in the first half, the pace increased in the reviewed half year, alongside a stable growth rate in the Home Prices Index.
The Research Department’s staff forecasts: The Research Department published four forecasts during the period being reviewed, in parallel with the interest rate announcements – in July, August, (an unscheduled update), October and January 2021. The forecast for October was joined by a special update in November, which was presented to the Committee, of 2020 growth data, in view of encouraging growth data in the third quarter. For most of the second half, the Research Department’s macroeconomic forecasts presented two possible scenarios, and during the course of the half year, the expected unemployment rate was revised upward. The two scenarios presented in the January forecast are a scenario including rapid vaccination of the population by May 2021 (hereinafter, the rapid vaccination scenario) and a scenario in which the vaccination is drawn out for a longer period of time until June 2022 (hereinafter, the slow vaccination scenario). As of now, in view of the rapid pace of vaccinations of recent weeks, it appears that as of the date of the publication of the report, the probability of the materialization of the rapid vaccination scenario is markedly higher than that of the slow vaccination scenario.
In the rapid vaccination scenario, GDP is expected to grow by 6.3 percent in 2021 and by 5.8 percent in 2022. The inflation rate in the preceding 4 quarters (ending in the fourth quarter of 2021) is expected to be 0.6 percent, and 0.9 percent in 2022. The broad unemployment rate (for ages 15+) is expected to decline until the 4th quarter of 2021 to 7.7 percent of the labor force, and to continue to decline gradually to 5.4 percent at the end of 2022. The government’s deficit is expected to be 8 percent of GDP in 2021 and 3.6 percent of GDP in 2022, so that the debt to GDP ratio will be 77 percent in 2021 and 75 percent in 2022. This assumes that the government takes policy steps (reducing expenditures and raising taxes) at magnitudes that are in line with the restraint derived from the expenditure ceiling set in law. Without such adjustment, expected expenditure, base on existing decisions, will lead to a deficit of about 4 percent of GDP in 2022.
During the reviewed half year, the Committee discussed the economic risks to the forecast, which depend to a great extent on epidemiological developments – in the features and number of lockdowns, which are liable to be different than assessments, their effectiveness, the level of infection over the winter and the time and pace of the public’s vaccinations against Covid -19 – but also on other economic risks, such as additional weakness of activity abroad and government steps, as well as political and budgetary uncertainty.
1 The decisions in 2020 were made on July 6th, August 24th, October 22nd, and November 30th, and the decision reached in 2021 was on January 4th.