Monetary policy: This report reviews monetary policy in the second half of 2019 and the beginning of the first half of 2020.[1] The Monetary Committee kept the interest rate unchanged at 0.25 percent during this time, though in the last months of 2019 it implemented accommodative policy by purchasing a considerable $3.8 billion in foreign exchange. The Bank also used forward guidance and reformulated it during the period reviewed in accordance with domestic and foreign developments. Early in the half-year, the Committee estimated that the future upward path of interest would be pursued gradually and cautiously, in a way that would support a process at the end of which inflation will stabilize around the midpoint of the target range, and to support economic activity. Over time, however, largely in view of changes in the global economic environment and the inflation environment, the Committee lowered its estimate of the future interest path and even alluded to the possibility of a rate reduction, in parallel with the Committee declaring that additional tools would be used to attain the Bank’s targets, if necessary.
Inflation environment: The inflation environment declined during the half-year reviewed. From July, the annual inflation rate slipped below the lower bound of the target after remaining within the target range in the first half of the year. One-year inflation expectations from the various sources also fell below the lower bound, strengthening the assessment that the Bank of Israel interest rate is expected to decline in the coming year. Inflation expectations for more than one year ahead edged down moderately but remained anchored within the target range. From October onward, the downturn in the inflation environment also found expression in a moderation in the rate of increase in the CPI excluding fruit, vegetables, and energy and in additional core-inflation estimates. The decline in the inflation environment was abetted by major downside surprises in the CPI for June and July. According to an analysis by the Research Department, presented to the Committee, the decrease in the inflation environment is traceable not to slackening demand but to supply-side forces.
Real domestic activity: Real activity data released in the period reviewed supported the Committee’s assessment that the economy is near full employment and that GDP growth approximates the potential growth rate. Ongoing tightness in the labor market was manifested in brisk upward movement of wages led by the business sector, a high job vacancy rate, and the lowest unemployment rate in Israel’s history. Several indicators, however, suggested that the tightness of the labor market slackened somewhat toward year’s end.
Fiscal policy: During the half-year reviewed, it became clear that the 2019 fiscal deficit would overshoot the target considerably. The Committee also mulled the acute fiscal uncertainty that is likely to continue well into the future due to the unpredictability of the political situation and the measures that the government, once formed, may take to cope with the large deficit.
Capital market developments: At the beginning of the review period, estimates derived from the Telbor market and professionals’ forecasts[2] suggested that the coming year would see one rate increase if not more. During the period, however, as monetary policy abroad changed direction and Israel’s inflation environment declined, the probability of a rate cut in the coming year steadily increased in accordance with the estimates from the two aforementioned sources. As for domestic yields, medium- and long-term government bond yields, both nominal and real, fell during the period reviewed, much as they did abroad, while short-term real yields increased slightly.
The housing market: The data released in the period reviewed showed an upturn in housing-market activity, reflected in a marked increase in transactions, foremost among first-home buyers, and expansion of new mortgage volume in view of the decrease in the weighted interest rate on mortgages. The year-over-year rate of increase in home prices was approximately 1.6 percent in the period reviewed, though data obtained at the end of the period showed a year over year upturn of 2.6 percent.[3] The year over year increase in the Owner-Occupied Housing Services Price Index (rent) slowed somewhat during the period reviewed, from 2.5 percent to 1.9 percent.
The global economy: Actual and expected global economic activity slowed considerably and downward risks accelerated in view of the U.S.–China trade war and Brexit. As a result, there was a turnaround in monetary policy around the world and many central banks, including the Fed and the ECB, lowered their interest rates. The Committee discussed the possible impact of adverse developments abroad on Israeli exports and noted that they carried the potential for adverse impact, particularly if manifested in the high tech industry. At the end of the period reviewed, uncertainty surrounding the balance of risks ebbed as elections in the UK and reports about agreement on the first phase of the U.S.–China trade accord brought the political situation into clearer focus.
Exchange rate: The shekel continued to appreciate against major currencies, as it did in the first half of 2019. Appreciation in nominal effective exchange rate terms came to 8.4 percent in the year to date. The Committee members reiterated that appreciation is the main impediment to the convergence of the inflation rate toward the midpoint of the target range. The Committee also noted that the protracted appreciation of the shekel may impair Israel’s exports in the future. From October onward, against the background of the Bank of Israel’s powerful intervention in the foreign-exchange market, the shekel’s appreciation against the dollar, euro, and in effective exchange rate terms was arrested.
The Research Department staff forecast: The Research Department issued three forecasts during the period reviewed, each corresponding to an interest announcement: in July and October 2019 and in January 2020. In the last-mentioned forecast, the Department estimated GDP growth at 3.3 percent in 2019, 2.9 percent in 2020, and 3.2 percent in 2021. Inflation expectations, excluding taxation and regulation, are 1.0 percent in 2020 and 1.4 percent in 2021. In the Department’s assessment, the monetary interest rate in one year ahead will remain at 0.25 percent or decline to 0.1 percent. Relative to its forecasts in July and October, the Department lowered its inflation and interest outlooks. Although it did not revise its GDP growth forecast for 2019, in the October forecast it reduced the outlook for 2020 by 0.5 percentage points.
[1] Covering decisions that were made on July 8, August 28, October 7, and November 25, 2019, and that of January 9, 2020.
[2] The reference is to the average of the professionals’ forecasts.