The guidance by the Bank of Israel (BOI), which cut its rate by 75 basis points in 2014, compares with its November guidance when its said the recent rate cuts had yet to be fully reflected in activity and inflation.
Israel's economy, which was hit by the military offensive into Gaza in July, has started to recover with economic activity expected to return to the path of growth from before operation "Protective Edge," which BOI staff estimate detracted about 0.3 percent from annual Gross Domestic Product due to the negative impact on tourism and private consumption.
For 2014 the BOI forecast GDP growth of 2.5 percent, slightly up from its September forecast of 2.3 percent due to an upward revision of first half GDP data. In the third quarter of 2014 Israel's GDP shrank by 0.09 percent from the second quarter for annual growth of 1.89 percent, down from the second quarter growth rate of 2.79 percent.
For 2015 the BOI forecasts growth of 3.2 percent, up from September's forecast of 3.0 pct, due to an improvement in global trade, the depreciation of the shekel currency in the second half of this year and a recovery in tourism. The sharp decline in oil prices is expected to support private consumption.
BOI staff also revised upwards its forecast for inflation in 2015 to 1.1 percent from the September forecast of 1.0 percent. Excluding the effect of a cut in electricity and water prices in January, inflation is seen at 1.5 percent.
Israel's headline inflation rate fell by 0.1 percent in November, the third consecutive month of deflation, and well below the BOI's 1.0-3.0 percent target range.
The main reason for the upward revision in the inflation forecast - which the BOI said was higher than forecasters' assessment and that of capital markets - was a 13 percent depreciation in the shekel against the U.S. dollar in the second half of 2014 compared with the first half. The main factor that will moderate inflation next year is the sharp fall in oil.
The BOI also said its staff expects the central bank's policy rate to remain at the current level of 0.25 percent and then start to rise in 2016, slightly lower than the average projection of forecasters who see a rise in the rate to 0.5 percent by the end of 2015.
The Bank of Israel issued the following statement with the main considerations behind its policy decision:
"The decision to keep the interest rate for January 2015 unchanged at 0.25 percent is consistent with the Bank of Israel's monetary policy, which is intended to return the inflation rate to within the price stability target of 1–3 percent a year over the next twelve months, and to support growth while maintaining financial stability. The path of the interest rate in the future depends on developments in the inflation environment, growth in Israel and in the global economy, the monetary policies of major central banks, and developments in the exchange rate of the shekel.
The following are the main considerations underlying the decision:
- The rate of inflation as measured over the previous 12 months was negative 0.1 percent, compared with negative 0.3 percent over the 12 months ending in October. Excluding the expected effect of a reduction in electricity and water prices, inflation expectations for the coming year from the various sources are near the lower bound of the inflation target range. According to the Research Department’s staff forecast, the inflation rate in 2015 is expected to be 1.1 percent, and net of the effect of the electricity and water price reductions it is expected to be 1.5 percent.
- Indicators which became available this month point to a recovery in activity after Operation Protective Edge, with the economy’s expected return to its path of growth from before the operation expressed in a relatively high growth rate in the coming quarters. Partial data from the fourth quarter Companies Survey support this assessment, and the Composite State of the Economy Index continues to increase at the moderate rate that has characterized it since the beginning of the year. All labor market indicators also signal continued improvement. Based on the Research Department’s staff forecast, growth in 2015 is expected to be 3.2 percent.
- There was considerable volatility in the foreign exchange market this month. Over the course of the month, the shekel appreciated by 0.2 percent in terms of the nominal effective exchange rate, and weakened by 2 percent against the dollar. Since the beginning of August, when the trend of depreciation in the effective exchange rate began, the shekel has weakened by 6.9 percent, and it has depreciated by about 3.7 percent since the beginning of the year. Continued depreciation will support a recovery in exports and in the tradable sector as a whole, and is expected to contribute to returning the inflation rate to within the target range.
- There are increasing signs that the US recovery is solidifying, while weakness continues in Europe, Japan and most emerging markets. The crisis in Russia was expressed in increased volatility in global financial markets. The decline in energy prices is expected to continue to reduce global inflation and to support the economic recovery. Financial markets are pricing in an initial increase in the US federal funds rate in the third quarter of 2015; in Europe and in other economies, monetary easing continues.
- Home prices increased sharply in September-October, even before the announcement of the cancellation of the zero-VAT plan, and it appears that there is an increase in the rate of mortgages being taken out and in new home sales. There were sharp increases in the number of building starts and building completions in the third quarter.
- This month, there was a slight increase in corporate bond market spreads, and extensive negative net new investment in bond funds.
The Monetary Committee is of the opinion that the current level of the interest rate supports the continuation of the recovery in economic activity, and the return of inflation to within the target range.
The Bank of Israel will continue to monitor developments in the Israeli and global economies and in financial markets. The Bank will use the tools available to it and will examine the need to use various tools to achieve its objectives of price stability, the encouragement of employment and growth, and support for the stability of the financial system, and in this regard will continue to keep a close watch on developments in the asset markets, including the housing market."