Monday, July 10, 2017

Israel holds rate as 2017 growth forecast raised

       Israel's central bank left its monetary policy interest rate at 0.10 percent, as widely expected, saying all data point to continued solid economic growth in the second quarter of this year and growth for the full year will be higher than previously forecast.
      The Bank of Israel (BOI), which has kept its rate steady since March 2015, said overall exports remained sluggish apart from rapid growth in the export of services against the background of a continued appreciation of the shekel and an improvement in world trade.
      Israel's Gross Domestic Product slowed to annual growth of 3.8 percent in the first quarter of this year, down from a pace of 4.6 percent in the previous two quarters.
      But BOI staff raised its growth forecast for this year to 3.4 percent from its previous forecast of 2.8 percent, as exports and investments had risen more than expected, with exports expected to continue to improve due to the expected recovery in world trade.
      Although growth this year is slower than 2016's 4.0 percent, data toward the end of last year was affected by vehicle purchases being brought forward due to changes in taxes in January 2017 so the BOI said growth in 2017 will in fact be similar to that in 2016.
       For 2018 the BOI retained its growth forecast of 3.3 percent as growth continues to transition to rely more on exports than private consumption. Further changes to vehicle taxes are expected in January 2019 which again is expected to lead purchases being pulled forward, raising 2018 growth.
     Israel's inflation rate rose slightly to 0.8 percent in May from 0.7 percent, slightly below the BOI's target range of 1-3 percent, with inflation expected to decline in coming months due to lower water and fuel prices, and a reduction in the prices of after-school childcare.
     The appreciation of the shekel is also keeping the cost of imported items down. One-year and three-year inflation expectations remain below the BOI's target tough longer-term expectations are within the target, the central bank said.
     BOI forecast annual inflation in the second quarter of 2018 at 0.8 percent and 1.5 percent for the year, down about 0.2 percentage points from previous forecast due to lower oil prices.
     The bank's forecast for the BOI policy rate was unchanged from April, with the rate remaining at the current level in the coming year before being raised in the second quarter of 2018 to 0.25 percent following a number of quarters when inflation is expected to exceed 1.0 percent and one-year inflation expectations move closer to the central of the target range.
     A second rate hike is then seen in the fourth quarter of 2018 when the rate is increased to 0.5 percent.
     Israel's shekel has been firming sharply this year though it fell in the last week. Today it was quoted at 3.55 to the U.S. dollar, up 8.4 percent this year.

       The Bank of Israel issued the following statement:

  • The annual inflation rate is slightly below the target, but the inflation environment remains low: inflation expectations for up to the third year remain below the target range. The increase in nominal wages, the strong economic environment, and inflation worldwide will act to increase the inflation rate, while the appreciation that has occurred in the shekel, increased competition in the economy and measures adopted by the government to reduce the cost of living will act in the opposite direction.
  • Indicators of activity point to continued economic growth at a solid pace in the second quarter as well, and the labor market remains strong. Over time, growth of exports has been based on growth of services exports, while goods exports have essentially stood still.
  • The global economy continues its moderate improvement, and there is an increase in the growth rate of world trade. In Europe, the recovery is becoming entrenched, and political risk has declined. The Federal Reserve increased the federal funds rate, as expected, but central banks of other major economies are continuing the very accommodative policy for now.
  • Since the last monetary discussion, there were relatively sharp changes in cross rates and the effective exchange rate appreciated by less than one percent. In the past 12 months, the effective exchange rate strengthened by 9.4 percent.
  • Stability in home prices has been apparent for the past several months, and housing market indicators continue to point to the market cooling off.

The Monetary Committee intends to maintain the accommodative policy as long as necessary in order to entrench the inflation environment within the target range. The Bank of Israel continues to monitor developments in inflation, the real economy, the financial markets, and the global economy, and will act to attain the monetary policy targets in accordance with such developments.

In recent months, the 12-month inflation rate has stabilized at slightly below the lower bound of the target range, and inflation for the 12 months ending in May was 0.8 percent (Figure 1 in the data file). With that, the inflation rate is expected to decline in the coming months, partly as a result of an expected reduction in water and fuel prices and in the prices of after-school childcare. The rate of increase in tradable goods prices remains negative against the background of the appreciation of the shekel, but continues to increase, impacted by relatively high inflation abroad. The rate of increase in prices of nontradable items has moderated, but is within the inflation target. (Figure 3). One-year expectations from the various sources ranged in opposite directions, but all remain below the target range. Third year forward inflation expectations also declined to below the target range, but longer term expectations are anchored within the range. The increase in nominal wages, the strong economic environment, and inflation worldwide will act to increase inflation, while the appreciation that has occurred, the increased competition in the economy, and measures adopted by the government to reduce the cost of living will act in the opposite direction.

All the indicators of economic activity point to the economy having continued its solid growth in the second quarter as well, as conveyed by preliminary data from the Companies Survey (Figure 10), the Purchasing Managers Index, the Consumer Confidence Indices, and the Composite State of the Economy Index. Foreign trade data indicate continued sluggishness in goods exports against the background of the continued appreciation of the shekel and despite the improvement in world trade. Export growth is based on rapid growth in services exports (Figure 12). The entrenchment of growth continues to be reflected in the labor market. The slight increase in the unemployment rate in April and May was accompanied by increases in the participation rate and in the employment rate (Figure 13), the job vacancy rate remains high, and the pace of wage increases continues to accelerate.

Housing market data continue to indicate moderation in demand and a slowing of activity. In recent months, home prices seem to have stabilized (Figure 7), and there were declines in the volume of transactions among all buyer types and in the volume of new home sales. The monthly pace of new mortgages granted continues to moderate, the increase in mortgage interest rates has been halted, and there is some decline apparent in those interest rates in recent months (Figure 8).

Global economic activity continues to improve moderately. The OECD raised its global growth forecast for 2017, and the improvement includes most major economies other than the US, for which the forecast was lowered (Figure 15). The increase in the growth rate of world trade continues, with an emphasis on emerging markets. The messages from several central banks were slightly less dovish, leading to an increase in bond yields, but with the exception of the US Federal Reserve, none of the major central banks changed their accommodative policy, and inflation in most major economies remains below the target (Figure 18). In the US, the assessment is that there was an improvement in the growth rate in the second quarter, following low growth in the first quarter, and the labor market is near full employment, but wage increases remain moderate and are not being translated into inflationary pressures. Assessments are that the administration will have difficulty implementing the fiscal expansion that was expected. In Europe, assessments are that growth continued at a relatively high pace in the second quarter, and political risk declined, which was reflected in, among other things, a decline in yield spreads between Germany and other European countries. In contrast, in the UK a slowdown is apparent due to the uncertainty regarding the Brexit process. In Japan, the Bank of Japan’s assessment is that the output gap has been closed, but inflation remains low. The economic data published in China indicate a continuation of relatively moderate growth. Energy prices declined slightly, and the prices of other commodities were stable.

The minutes of the monetary discussions prior to this interest rate decision will be published on July 24, 2017. 
The next decision regarding the interest rate will be published at 16:00 on Tuesday, August 29, 2017. "


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