Monday, February 26, 2018

Israel maintains rate as inflation expectations rise

       Israel's central bank left its key interest rate at 0.10 percent, as widely expected, saying inflation expectations have recently risen although inflation is likely to decline temporarily in coming months.
       The Bank of Israel (BOI), which has maintained its rate since March 2015, also affirmed its guidance that it intends to maintain its accommodative monetary policy "as long as necessary in order to entrench the inflation environment within the target range."
       BOI targets inflation of 1.0 to 3.0 percent and expects inflation to enter its target range in the second half of this year, with the central bank then raising its rate to 0.25 percent end-year.
       Israel's inflation rate eased to 0.1 percent in January 2018 after inflation was positive most of 2017 - the first time in three years - albeit below the bank's target. In December the inflation rate was 0.4 percent.
       Despite the temporary drop in inflation in coming months for seasonal reasons and due to government price reductions, the BOI said the depreciation of the shekel in the past month - to the extent that it persists - along with higher wages, will support the return of inflation to the target range.
       In the past month inflation expectations derived from capital markets had risen to 0.8 percent for the coming year, BOI said.
       Last year Israel's economy performed well, helped by exports, with Gross Domestic Product up by a seasonally-adjusted annual 3.6 percent in the fourth quarter, and employment was full.
      "Economic activity continues to expand in line with the potential growth rate," said BOI, which has forecast growth this year and 2019 by around 3.5 percent.
       After steadily rising since March 2015, the shekel has weakened this year, with the BOI saying it lost 3.1 percent in terms of the effective exchange rate and by 1.6 percent against the U.S. dollar since the last meeting of its monetary policy committee on Jan. 10.
      Today the shekel was trading at 3.49 to the dollar, only slightly down from 3.47 at the start of the year.

       The Bank of Israel released the following statement:

      The inflation environment remains below the target, but there has been some increase in inflation expectations for the short and medium terms. In the coming months a temporary decline in the annual inflation rate is expected. The depreciation that occurred in the past month, to the extent it persists, as well as the wage increase in the economy, will support the return of inflation to the target range.
·      Economic activity continues to expand in line with the potential growth rate. Growth in 2017 was more balanced. Against the background of the rapid growth in world trade, there was positive growth in goods exports, despite the appreciation, and services exports increased at a solid pace. In contrast, investment in residential construction has declined for the past three quarters. Labor market data continue to indicate a high level of activity in a tight labor market. Recent indicators support the assessment that the growth of economic activity is continuing in the first quarter of 2018.
·      The improvement in the global economy is solidifying, and forecasts for growth and world trade continue to be revised upward. The correction in global equity markets has halted as of now. In the US, the federal funds rate is expected to continue to increase, while most central banks continue to adopt accommodative monetary policy, but financial markets are pricing in a somewhat less accommodative future policy path.
·      Since the last interest rate decision, the shekel has weakened by 3.1 percent in terms of the effective exchange rate, and by 1.6 percent against the dollar. In January, the Bank of Israel intervened in the foreign exchange market, buying $1.8 billion.
·      Housing market data continue to indicate a slowing of activity. There were declines in home prices according to the last three monthly readings.

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.

For the file of data accompanying this notice, click here.

The inflation environment remains low. The CPI for January declined by 0.5 percent, and low inflation is expected in the coming two months as well, in accordance with the seasonal path and due to price reductions initiated by the government (Figure 2 in the attached data file). However, in the past month inflation expectations increased: expectations for the coming year derived from the capital market rose to 0.8 percent, and the average of professional forecasters’ projections is similar (Figure 4). There was also an increase in capital market expectations for the medium terms (Figure 5): Second-year forward expectations are around the lower bound of the target range, and third-year forward expectations are within the range. Expectations for longer terms continue to be anchored within the target range. The increase in expected inflation occurred against the background of the depreciation of the shekel in the last month (Figure 6). To the extent that the depreciation will persist, it is expected, together with the impact of wage increases, to support the continued increase in inflation.

Since the previous interest rate decision, government bond yields increased in Israel and abroad. The increase in Israel was more moderate than that in the US, so that the yield gap increased (Figure 7). Spreads between corporate bond yields and government bond yields increased slightly but remain very low, similar to the trend worldwide.

Economic activity continues to expand at a pace in line with its potential growth rate (Figure 10). Based on the first estimate of fourth quarter National Accounts data, the economy grew in the fourth quarter of 2017 by 3.6 percent (seasonally adjusted, in annual terms). Exports in the fourth quarter grew at a relatively high rate, and with export data from previous quarters being revised upward, it appears that for 2017 overall, growth was more balanced than previously assessed (Figure 11). Exports (excluding diamonds and startup companies) grew by 5.3 percent in 2017. Services exports increased at a rapid rate, but goods exports (excluding diamonds) also increased (by 2.5 percent, Figure 12), against the background of the solid growth in world trade (Figure 18) and despite the appreciation of the shekel. Investment grew moderately, relative to 2017, and there was a sharp decline in investment in residential construction. Indicators of activity in January point to the economy growing at a similar pace in the first quarter of 2018 as well (Figure 13). The labor market remains tight, with continued improvement in various figures—the participation and employment rates increased (Figure 14), the unemployment rate declined, wages increased (though its rate of growth has moderated in recent months, Figure 15), and the ratio of job vacancies to the number of unemployed people is high.

Housing market data continue to point to a slowing of activity. The last three monthly readings of home prices showed declines, so that the annual rate of increase moderated considerably (Figure 8). The number of transactions continues to decline due to the prolonged decrease in transactions by people upgrading their homes. New mortgage volume continues to increase slightly, following its extended decline, with a continued slight decrease in interest rates (Figure 9).

Global economic data indicate that the improvement is solidifying, and the IMF again revised upward its growth forecasts for major economies and for world trade (Figure 17). The equity market declines stopped a continued string of increases in most markets, and have halted as of now (Figure 19). Most economies continue to adopt accommodative monetary policy, but financial markets are pricing in a somewhat less accommodative future policy path. The US economy is around full employment and is expected to continue to grow at a solid pace in the coming years, against the background of fiscal policy that is expected to be very expansionary, while leading to an increase in the deficit and debt. The Federal Reserve is expected to increase the federal funds target rate at its upcoming meeting, and twice more during 2018. In 2017, the eurozone economy grew by 2.5 percent—the highest rate in the eurozone in the past decade, and the improvement encompasses most of its member countries. The ECB kept the accommodative monetary policy in place and signaled that it is expected to continue. Growth in Japan continues, but inflation is still low and the accommodative policy is expected to remain in place. Improvement in economic activity was also seen in China and other emerging economies. Crude oil prices were volatile after a prolonged increase (Figure 21)."


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