Download October 24, 2011

BANK OF ISRAEL
Office of the Spokesperson and Economic Information
PRESS RELEASE
October 24, 2011
The Bank of Israel leaves the interest rate for November 2011 unchanged at 3
percent
The current interest rate decision was made by the Monetary Committee in
accordance with the new Bank of Israel Law. The Monetary Committee has six
members. Three are from the Bank—Governor of the Bank of Israel Prof. Stanley
Fischer, who serves as chairperson of the committee, Deputy Governor Dr. Karnit
Flug, and Barry Topf, Senior Advisor to the Governor. The other three members of
the committee are from the public—Prof. Reuben Gronau, Prof. Rafi Melnick, and
Prof. Alex Cukierman.
The Bank of Israel notice of the confirmation of their appointment can be accessed at the
Bank's website:
http://www.boi.org.il/press/eng/111009/111009n.htm
Background conditions
Inflation data: The Consumer Price Index (CPI) declined 0.2 percent in September,
below forecasts which on average predicted no change, and within the seasonal path
consistent with achieving the inflation target. The food prices component of the index
continued to decline, among other reasons against the background of the social
protest. This month, the rate of inflation over the past 12 months, as measured by the
change in the CPI, entered the target range (1–3 percent per year) and is now 2.9
percent. The rate of inflation, seasonally adjusted, over the past seven months has
been around the lower limit of the inflation target range.
Inflation and interest rate forecasts: Inflation expectations as calculated from the
capital markets, which reached around 2 percent toward the end of September,
declined in October and are at 1.6 percent on average. Expectations fell primarily for
the short term—for the medium and longer periods expectations remained steady at
2.3 percent. Forecasters' inflation predictions for the next twelve CPI readings were
2.2 percent on average, slightly below last month's average. The decline in
expectations of inflation took place against the background of continued expectations
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for a slowdown in growth world wide and in Israel, as well as the lowering of prices
by retail chains and service providers, influenced by the social protest against the high
cost of living. At the same time, forecasts of the Bank of Israel interest rate continued
to fall. Based on the Telbor (Tel Aviv Inter-Bank Offered Rate) market, the Bank of
Israel interest rate one year from now is expected to be 2.7 percent, down from 3
percent a month ago, and the average of forecasters' predictions is that it will be 3
percent, down from 3.15 percent a month ago. Most forecasters expect the Bank of
Israel to leave the interest rate for November unchanged, and on average they expect
the interest rate to be reduced by 0.3 percent in the next three months.
Real economic activity: Economic indicators that became available this month
support the assessment of recent months that the rate of growth of the economy is
lower than that of the first quarter of 2011. The growth of both domestic demand and
goods exports declined. Based on foreign trade figures (seasonally adjusted) industrial
exports declined around 4.3 percent in the third quarter, compared with the second
quarter. In contrast, imports were mostly unchanged, primarily due to an increase in
imports of investment goods. In September, the goods trade deficit continued to
widen, as it had over recent months. The Bank of Israel's Companies Survey for the
third quarter shows that the economy continues to expand, though at a more moderate
pace than in previous quarters. With that, in most industries the expectations for the
fourth quarter range from a freeze in activity to a moderate drop in activity. The
Central Bureau of Statistics survey of business trends as well as the Globes and the
Bank Hapoalim consumer confidence indices point to a decline in the public's planned
consumption. The Purchasing Managers Index, compiled by Bank Hapoalim and the
Israel Purchasing and Logistics Managers Association, fell sharply and in September
was below 50. Tax receipts in September were 4 percent lower than forecast, a
continuation of the slowdown that began in April.
The labor market and wages: Labor market data indicate a high level of
employment and a low unemployment rate. The rate of growth of the number of
employed has moderated in recent months. The trend rate of unemployment for July
was unchanged at 5.4 percent. The number of Israeli employee posts (seasonally
adjusted) increased by 2 percent in May–July, in annual terms, compared with the
preceding three months. The nominal wage rose in May–July by 1.5 percent,
compared with the three previous months (seasonally adjusted), and the real wage was
unchanged. In September, health tax receipts, which provide an indication of wage
payments in that month, were 9 percent higher (preliminary estimate), in nominal
terms, than in September 2010 (excluding the effect of legislative changes).
The Bank of Israel Research Department staff forecast: According to the Research
Department staff forecast (from September), inflation over the four quarters ending in
the third quarter of 2012 will be 2.3 percent, and the average interest rate for 2012
will be 3 percent. GDP growth for 2011 is forecast to be 4.7 percent, and 3.2 percent
in 2012. The assessment is based on, among other things, a lowered International
Monetary Fund (IMF) forecast for global growth and world trade. This month the
Research Department examined the possible effect on Israel's economy of a scenario
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in which global growth is 1 percentage point lower than the base scenario. If the lower
growth scenario develops, GDP growth in Israel is forecast to be about 0.5 percentage
points lower in 2012 than in the base scenario. Inflation over the four quarters ending
in the third quarter of 2012 is forecast to be 0.8 percentage points lower than in the
base scenario, and the average interest rate for 2012 is expected to be 1 percentage
point lower than in the base scenario.
Budget data: Government domestic revenues for the year to date through September
were 3.1 percent lower than the seasonal path of the budget forecast, due to a
continued slowdown in indirect tax receipts, which began in April. The overall
government deficit (excluding net credit) in the year to date was NIS 9.7 billion,
compared to a deficit of NIS 14 billion in the corresponding period of the year before.
Developments in government activity so far indicate that tax revenues will be slightly
lower than the budget forecast, and the budget deficit for the full year of 2011 will be
around the deficit ceiling set by law—3 percent of GDP.
The foreign exchange market: From the previous monetary policy discussion held
on September 25, through October 21, the shekel appreciated by about 1.8 percent
against the dollar, in line with the general trend, but at a moderate level compared
with the performance of currencies of developed countries. In contrast, the shekel was
essentially unchanged against the euro (depreciation of 0.02 percent). The shekel
strengthened by about 0.8 percent in terms of the nominal effective exchange rate.
The rate of participation by nonresident investors in foreign currency trading was 26
percent in October, compared with 32 percent in September, while the average for the
year to date in 2011 is 34 percent.
The capital and money markets: From the previous monetary policy discussion held
on September 25, through October 21, the Tel Aviv 25 Index increased by 5.9
percent, with relatively high volatility, similar to the trend on most stock markets
around the world. The government bond market responded with declining rates for
most maturities. Returns declined 10-16 basis points across most of the yield curve of
unindexed bonds, and yields on CPI-indexed government bonds declined by up to 6–
12 basis points for most maturities. The yield gap between Israeli 10-year government
bonds and equivalent 10-year US Treasury securities contracted to about 250 basis
points, from 290 basis points in the previous month. Makam yields fell by up to 25
basis points across the yield curve, as the yield for one year fell during the period
from 2.98 percent to 2.8 percent—against the background of the interest rate cut by
the Bank of Israel last month, and expectations of similar moves in coming months.
Withdrawals from mutual funds specializing in corporate bonds continued this month,
although at a slower pace than that in the previous month. Over the period as a whole,
Israel's sovereign risk premium as measured by the five-year CDS spread declined,
and narrowed to 160 basis points from last month's 218 basis points. The Tel-Bond
indices rose around 2 percent.
The money supply: In the twelve months ending in September, the M1 monetary
aggregate (cash held by the public and demand deposits) increased by 0.5 percent, and
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the M2 aggregate (M1 plus unindexed deposits of up to one year) increased by 13.1
percent.
Developments in the credit markets: The balance of outstanding debt of the
business sector increased in August by 1.5 percent, to NIS 768 billion. Outstanding
credit to households increased by 0.4 percent in August, to NIS 359 billion. Of the
credit to households, outstanding housing credit rose 10.9 percent in the twelve
months ending in August, to NIS 255 billion, compared with an 11.8 percent increase
in the twelve months to July. The volume of new housing credit granted in the twelve
months ending in September was slightly lower than in the twelve months ending in
August—a continuation of consecutive declines since the record high set in May. The
share of unindexed floating rate mortgages extended in September rose to 26.8
percent, from 26.1 percent in August. These percentages are significantly lower than
the record levels of the first quarter of 2009—about 75 percent on average. The
interest rates on floating rate mortgages, both CPI-indexed and unindexed, continued
to increase in August, while the interest rates on fixed rate CPI-indexed mortgages
declined.
The housing market: Activity in the construction industry continues to be strong.
The number of starts in the twelve months to July reached 42,910, compared with
42,059 the month before, and the number of completions was 33,138, compared with
33,740 the previous month (Ministry of Construction and Housing figures).The
number of homes available for sale continued to increase, and in June–August was on
average 9.1 percent higher than in the three preceding months (original data). The
construction sector continued to expand in the third quarter, according to figures from
the Bank of Israel's Companies Survey, and expectations in the sector are for
continued growth in activity in the fourth quarter as well.
Housing prices reflected in the housing index, which is based mainly on renewed
rental contracts and which is included in the CPI, continued to increase at a relatively
rapid pace, rising 0.9 percent in September, and by 5.5 percent in the past twelve
months, and prices are expected—according to the Research Department forecast—to
continue to increase at a similar pace in the coming year. Home prices, which are
published in the Central Bureau of Statistics survey of home prices but are not
included in the CPI, increased at a monthly rate of 0.8 percent in July and August,
after rising 0.4 percent in June and July. The annual rate of increase in home prices
remains high and relatively stable. In the twelve months ended in July home prices
increased by 12.1 percent; compared with a 12.3 percent increase in the June figure
and a 12.1 percent increase in May—this follows levels of around 20 percent in 2010.
The slowdown in the rate of increase in home prices comes against the background of
the continued increase in the number of building starts, the lagged effect of the
increase in the interest rate, measures introduced by the Bank of Israel affecting
mortgages, and steps taken by the Ministry of Finance in real estate taxation. The
effect of these moves is expected to continue and be evident going forward.
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The global economy: Uncertainty about the continuation of the global economic
recovery increased this month, primarily against the background of difficulties in
major economies, the financial crisis in Europe, and lack of clarity regarding rescue
plans developing in Europe. Growth forecasts for Europe for 2011 and 2012 were
revised down. The base scenario is for a standstill in Europe and low growth in the
US. There are also the first signs of moderating economic activity in emerging
markets. Europe continues to be the focus of risk factors—the probability of negative
growth, even in core economies, increased significantly, and recently, the growth
forecast in Germany for 2012 declined by half, to 0.8 percent. Concern regarding a
severe financial crisis remained high, due to risk spreading to leading banks in
Europe, liquidity difficulties in the banking system, and lowered ratings of leading
banks in the world. These background conditions led policy makers in Europe to
announce a wide ranging aid plan, and led major central banks (the Fed, ECB, and
BOE) to undertake further measures of monetary easing. With that, the aid plans
developing in Europe and relatively good macroeconomic figures in the US, led to
gains in main stock indices.
The main considerations behind the decision
The decision to leave the interest rate for November unchanged after reducing it for
October is in line with monetary policy aimed at stabilizing the rate of inflation within
the price stability target range of 1–3 percent over the coming 12 months, and is
intended to support growth while preserving financial stability. The path of the
interest rate in the future depends on developments in the inflation environment,
growth in Israel, the global economy, the monetary policies of major central banks,
and developments in the exchange rate of the shekel.

Inflation expectations for the coming 12 months, both those calculated from the
capital market and those of forecasters, continued to decline within the inflation
target range and are currently 1.7 percent and 2.2 percent, respectively. The rate of
inflation over the previous 12 months entered the target range in September, for
the first time since December 2010, and is currently 2.9 percent. The rate of
inflation, seasonally adjusted, over the past seven months has been around the
lower limit of the inflation target range.

Economic indicators that became available this month indicated that local
economic activity continued to expand, but at a slower pace than in 2010 and the
first quarter of 2011. The slowdown in the growth of the local economy was
primarily a result of moderation in global demand and its impact on exports, but
some weakness also began to be evident in domestic demand.

Concerns of a negative turnaround in the eurozone remained, primarily in light of
the difficulties in formulating a rescue plan for countries suffering debt crises. In
the US, while concerns of a negative turnaround have not dissipated, recent
figures on activity were better than expected. With that, the level of uncertainty
regarding developments in the global economy remains especially high, and
clearly impacts on uncertainty regarding developments in Israel's economy.
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
The negative turnaround in Europe and the slow growth in the US have led to the
markets not pricing in an interest rate increase over the coming year by the central
bank of any large advanced economy. The Federal Reserve has said that the fed
funds rate is expected to remain at its near zero level until at least the middle of
2013. The Fed and ECB continued monetary expansion programs.

The rate of increase in home prices over the twelve months which ended in
August remains relatively stable at a high level of over 12 percent, though low
compared with last year's 20 percent levels. With that, the sustained increase in
building starts, the lagged effect of the increase in the interest rate, measures taken
by the Bank of Israel with regard to mortgages, and changes in real estate taxation
introduced by the Ministry of Finance, are expected to continue to contribute to
moderation in home prices over the coming year.
Maintaining the interest rate at its current level leaves the Bank of Israel room to
respond to events in the global and local economies.
The Bank of Israel will continue to monitor developments in Israel's economy and the
global economy and in the financial markets. The Bank will use the tools available to
it to achieve its objectives of price stability, the encouragement of employment and
growth, and support for the stability of the financial system, including keeping a close
watch on developments in the assets market, and especially in the housing market.
The minutes of the discussions prior to the above interest rate decision will be published on November
7, 2011.
The decision regarding the interest rate for December 2011 will be published at 17:30 on Monday,
November 28, 2011.
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