Monetary Policy Report Second Half of 2022
According to the Bank of Israel Law, 5770–2010, the Bank of Israel has three objectives: (1) to maintain price stability, as its central goal; Price stability is defined as an annual inflation rate of between 1 percent and 3 percent; (2) to support other objectives of the government’s economic policy, particularly growth, employment and reducing social gaps, provided that this support does not prejudice the attainment of price stability; and (3) to support the stability and orderly activity of the financial system.
In accordance with Section 55(a) of the Bank of Israel Law, 5770-2010, this report is submitted by the Bank of Israel to the government and the Knesset Finance Committee twice annually. The report surveys the economic developments that took place during the period covered by the report. It also surveys the policy required—in the view of the members of the Bank of Israel’s Monetary Committee, the forum in which monetary policy decisions are reached—to maintain the inflation rate within the range set by the government and to achieve the other objectives of the government’s economic policy. The economy’s financial stability is surveyed by the Bank of Israel in its Financial Stability Report.
In accordance with Section 55(b) of the Bank of Israel Law, the current report explains why the inflation rate deviated from the target range determined by the government for more than 6 consecutive months—from the publication of the CPI for January 2022 (on February 15, 2022) through the publication of the CPI for November 2022 (on December 15, 2022). The inflation rate during this period exceeded the upper bound of the target range, and the explanations for that are found in Section A below (Policy and goals).
The Monetary Policy Report for the second half of 2022 was prepared by economists in the Research Department, within the guidelines set by the Monetary Committee. The report is based on data published up to the interest rate decision reached on January 2, 2023.
This report surveys the monetary policy during the second half of 2022 and the interest rate decision in January 2023. During this period, the inflation rate in Israel remained above the upper bound of the target and was characterized by volatility, although this rate continued to be low compared to most advanced economies. In the past two years, prices increased in Israel due to a combination of supply factors and in particular external ones, with the most significant ones being the impacts of the war between Russia and Ukraine, which led to a marked increase in prices of energy and commodities, and by continued disruptions in supply chains. However, there were also domestic demand factors, against the background of the economy’s return to employment rates higher than those that prevailed before the COVID-19 crisis, which indicated the existence of a tight labor market.
During the half year reviewed, there were increasing signs that price increases are broad, and the Committee assessed that inflation in Israel derives to a large extent from an increase in domestic demand. The Committee also assessed that the monetary tightening processes in Israel and abroad, the moderation of demand, alongside the easing in supply chain disruptions and the decline in prices of oil and other commodities, act to moderate the inflation rate in Israel. In contrast, the Committee assessed that there is uncertainty regarding the extent of fiscal expansion and wage developments in the economy, and that those will have an impact on the pace of inflation converging to its target.
Monetary policy: The monetary restraint was carried out in 2022 mainly through a calculated and determined increase in the monetary interest rate. Within the framework of 4 interest rate decisions reached in the second half of 2022, the Committee decided on an increase of the interest rate by 2.50 percentage points, from 0.75 percent (in June) to a rate of 3.25 percent at the end of 2022. In January 2023, the interest rate was increased by another 0.5 percentage points, to 3.75 percent. The monetary contraction policy that was implemented was a direct continuation of the process that began in 2021, with the end of the bond purchase program and of the use of the other special tools that were operated during the COVID-19 crisis. There were also no foreign exchange purchases in the second half of 2022. The monetary policy during this period was characterized by an acceleration of interest rate increases compared to the interest rate increase expected for that period according to the forecasts at the time. That is, the Committee decided to adopt front loading, similar to other central banks around the world.
The inflation environment: The second half of 2022 was characterized by a high inflation environment relative to previous years. The year over year inflation rate remained above the upper bound of the target throughout the half year, and was characterized by volatility. The year over year inflation rate in November was 5.3 percent. However, the inflation rate in Israel was lower than the rate in most advanced economies. During the half year, the inflation expectations in Israel for short terms, for 1 year, and the 1-year, 1-year forward expectations were in the environment of the upper bound of the target range, and at times were slightly above it. Inflation expectations for longer periods (more than 2 years) continued to be anchored within the target range.
Domestic real activity: The data and indicators presented to the Monetary Committee in the half year reviewed continued to indicate solid growth figures, but the most recent data showed a slight decline in the growth rate. During the half year, the GDP level continued to be higher than the long-term trend line of before the COVID-19 crisis. The current indicators continued to point to a level of economic activity that was robust, though some of them indicated moderation in third-quarter growth, which was reflected in, among other things, a slight decline in goods exports and an increase in the number of companies reporting an increase in the magnitude of the difficulty caused due to a lack of orders. Looking forward, the Committee assessed that there are increasing signs of a global economic slowdown and that these are liable to leave their mark on Israel’s economy as well.
The labor market: The labor market remained tight in a full employment environment in the half year reviewed, with some slackening seen in data at the end of the period—a moderate increase in the unemployment rate and a slight decline in the employment rate. Nominal wages among the prime working ages (25–64) continued to increase during the period, and still remain above the pre-crisis trend; in real terms, wages, in the most recent data, are near the trend that was forecast before the crisis.
Exchange rates: In the second half of this year, the shekel had a mixed trend. In the beginning of the period, the shekel appreciated against major currencies, but later on it depreciated markedly. From October through the middle of December, the nominal effective exchange rate was relatively stable. This stability reflected mixed trends of the shekel strengthening against the dollar and weakening against the euro. At the end of the reviewed period, the shekel depreciated further.
The global economy: The slowdown in global economic activity that occurred against the background of the war in Ukraine, the energy crisis in Europe and the slowdown in China, continued in the reviewed half year. The beginning of the period was characterized by continued disruptions in supply chains, which led to inflation pressures and a slowing in global activity, but as it proceeded there were some easing in those disruptions.
The increase in inflation around the world led to monetary restraint by central banks. This trend strengthened over the course of the half year, with many central banks adopting a process of bringing forward and accelerating the pace of the interest rate increases (front loading). These steps, together with the other global developments, contributed to a continued slowdown in economic activity, and global growth forecasts were revised downward. In the half year reviewed, the inflation environment worldwide remained markedly higher than central bank targets, though there are some countries in which moderation in inflation is becoming apparent. In view of these trends, the monetary contraction continued around the world, but some central banks began to signal a future slowing in the pace of contraction, and some even began to slow the pace of monetary contraction.
The credit market: The growth rate of new bank credit to the business sector in Israel slowed during the half year, and in parallel there were increases in the interest rate. However, nonbank credit (mainly corporate bonds) continued to expand, and a notable portion of it was directed to the construction and real estate industry. Additional signs of a possible cooling of the business credit market were seen in Business Tendency Survey data, which pointed to some increase in companies’ financing difficulties, though they remain low. New mortgage volume, after reaching a record in the beginning of the year, contracted during the course of the half year, though it remains high. New mortgages were characterized by a loan to value ratio (LTV) similar to the average over the past 2 years, but the payment to income ratio (PTI) continued to increase.
Developments in the financial markets: Financial markets in Israel and worldwide developed similarly over the reviewed half year. Equity indices increased in the beginning of the half year, and in parallel, government bond yields declined. Later on, in view of a slowing in global activity and the restrictive monetary policy, there was a change in the trend and there were sharp declines in equity indices, and government bond yields increased. From October through December, in view of the slowing in the pace of interest rate increases, equity indices worldwide increased and government bond yields in Israel and abroad remained essentially unchanged. However, from November there were declines on the domestic capital market, beyond the global trend. Domestic government bond yields increased markedly at the end of the reviewed period.
Developments in financial system stability: The increase in inflation worldwide alongside the increase in interest rates, increased the cost of debt, both for governments and for the private sector and markedly increased the risk for global recession. Although Israel is impacted by global developments, for now it is only moderately. The balance of business credit to the construction and real estate industry remains at a high level.
The housing market: The rise in home prices and rents continued to accelerate in the reviewed period. As of November, home prices rose by approximately 20 percent in annual terms. In parallel, rent prices also accelerated by a high rate compared to previous years.
Fiscal policy: In 2022, there was a surplus in government activity of 0.6 percent of GDP. Domestic expenditures stabilized during the half year reviewed at a markedly lower level than what characterized the government during the COVID-19 period and compared to 2019. In parallel, domestic revenue continued to increase at a pace higher than expected based on the various forecasts. Anomalous revenues derived mainly from a high level of net income tax collected, including a one-off collection campaign, and property tax revenues.
The Research Department forecast: The Research Department published three forecasts in the reviewed half year, simultaneously with interest rate announcements in July 2022, October 2022, and January 2023. According to the January 2023 forecast, GDP is estimated to grow in 2022 by 6.2 percent, a higher rate than assessed in the forecasts published in July and October. In contrast, the growth rate for 2023 was revised downward. The level of GDP at the end of 2023 is expected to be higher than assessed in the beginning of the half year, in July. The unemployment rate, according to the forecast, is expected to be 4 percent in 2023, on average. The debt to GDP ratio in 2022 and 2023 is expected to be lower than assessed in the beginning of the half year, at about 62 percent in each of the years. In addition, the inflation rate in 2023 is expected to be around the upper bound of the target, and the Bank of Israel interest rate is expected to be 4 percent in a year, according to the forecast.