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BANK OF ISRAEL
Office of the Spokesman and Economic Information
Press Release
August 7, 2012
Monetary Policy Report January-June
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Monetary policy: For the year to date, through the end of June 2012 (the period
reviewed in this report), the Monetary Committee of the Bank of Israel reduced the
interest rate once, for February, by 0.25 percentage points to a level of 2.5 percent
and left it at that level until the end of the period. At the end of the period being
surveyed, the Committee decided to lower the interest rate for July by 0.25 percent,
and to leave the interest rate for August unchanged at 2.25 percent. Monetary policy
was formulated to strengthen the ability of the economy to deal with the deepening
recession in the global economy and with its potentially adverse effects on Israel’s
economy. The policy decisions during the period being surveyed were subject to a
high level of uncertainly regarding the trend in GDP, as the indicators of economic
activity were mixed. Thus, although there were indicators of continued slowdown in
the growth of GDP, there were also indicators of stable growth and even some
acceleration.
Inflation: In the half year surveyed, the CPI rose by 1.0 percent since the beginning
of the year. The trend of decline in the annual rate of increase in the CPI, which
began in July 2011, continued in the half year reviewed. At the end of the period, the
rate of increase was only 1.0 percent, at the lower bound of the inflation target
range. Excluding the housing and energy components, the CPI declined by 0.6
percent during the previous 12 months. Expectations of inflation for the next 12
months rose during the first quarter to about 2.5 percent and then returned to the
center of the target range during the second quarter.
Real economic activity: The economy’s annualized rate of growth slowed during the
period being surveyed to about 3 percent. The slowdown in the growth rate of the
domestic economy, which began in the second quarter of last year, continued during
the six months being surveyed. Consumption, exports and fixed capital formation
increased moderately while imports rose sharply. The unemployment rate increased
somewhat during the period being surveyed, as did the rates of employment and
participation. However the rate of unemployment was still low compared with the
past.
The global economic environment: The level of economic activity in the eurozone
was unchanged during the first quarter of the year and it appears to have contracted
during the second quarter, simultaneous with the worsening debt crisis in a number
of eurozone countries and the increasing concern that one or more countries will
leave the eurozone. In the major emerging economies, the slowdown in growth
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intensified. In the US, moderate growth continued in the first quarter; however,
during the second quarter, indictors again pointed to a weakening of activity. The
central banks intensified their expansionary monetary policies through maintaining
low interest rates and continuing the injection of liquidity into European markets.
The exchange rate: The shekel strengthened against the euro and weakened against
the dollar; however, it remained stable in terms of its nominal-effective exchange
rate, though it depreciated somewhat towards the end of the period—a depreciation
which continued and strengthened afterwards as well. The relative stability in the
nominal-effective exchange rate of the shekel during the six months being surveyed
is a result of two offsetting forces: the deficit in the current account and the decline
in the interest rate gaps relative to abroad (following the reduction in the interest
rate for February), which provided support for a depreciation; and the favorable
situation of the Israeli economy relative to other countries, which provided support
for an appreciation.
The financial markets: In contrast to leading share indices worldwide, the share
markets in Israel fell during the first half of the year, accompanied by a decline in
trading volume. The yield to maturity of government bonds, both indexed and
unindexed, declined during the period being surveyed, similar to the trend
worldwide. In contrast, the yield gaps between corporate and government bonds
widened, due to the effect of increases in the yields on bonds of a number of large
business groups in the economy. The financial holdings of nonresidents, primarily in
government bonds and makam, continued to shrink during the period being
surveyed. Total credit to the business sector increased by 3.1 percent during the
period being surveyed (until May, in annual terms), after having risen by 3.2 percent
in 2011. The ratio of business credit to business sector output continued to remain
stable.
Home prices: The rate of increase in home prices continued to moderate during the
half year being surveyed, a trend that has continued since the beginning of 2010,
and reached an annual rate of growth of 2.1 percent in April. Nevertheless, the
decline in home prices during the last half of 2011 was halted during the period
being surveyed. There was a minor upturn in activity in the housing market during
the first half of the year, which was reflected in the increased volume of mortgages
and number of transactions. Furthermore, the level of building starts is still high,
though it fell last year, and this is having an effect in the direction of lower home
prices.
The forecast: Based on the staff forecast which was formulated at the end of June
2012, the Research Department estimates that the rate of inflation during the next
four quarters will reach 2.4 percent, which is somewhat above the center of the
inflation target range and somewhat lower than the previous forecast of 2.6 percent.
The rate of growth in GDP is expected to total 3.1 percent in 2012, which is a
continuation of the moderate growth during the second half of 2011 and is
unchanged relative to the previous forecast. According to the forecast, the Bank of
Israel interest rate is expected to remain unchanged at a level of 2.25 percent until
the end of 2013, in view of the expected continuation of the slowdown in real
economic activity and the expected inflationary environment during the coming
year. The expected path of the interest rate is lower than in the previous forecast,
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which estimated that the interest rate would remain unchanged at 2.5 percent. The
main risk to real economic activity in Israel is the possibility of a financial crisis in
Europe that would lead to a worsening of the recession there. During the month of
July 2012 (after the period being surveyed), there were additional indicators (and
revisions) that strengthened the assessment of an actual and expected slowdown in
economic activity. Should these indicators remain at such levels, it may be assumed
that as part of the next forecast by the Research Department (at the end of
September 2012) the forecasts of inflation and growth for 2013 will be revised
downward.
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