The following report was released by the Bank of Israel on 19 Tishrei 5774.

Background conditions

Inflation data: The Consumer Price Index (CPI) for August increased by 0.2 percent, below projections of 0.4 percent on average. The main contributions to the increase in the CPI were a seasonal increase in the housing component and increases in energy product prices. These were offset by a seasonal decline in the clothing and footwear component and by a decline in fruit and vegetable prices. With the high monthly CPI increase in August 2012 taken out of the calculation, there was a sharp decline in the rate of inflation measured over the past 12 months, to 1.3 percent.

Inflation and interest rate forecasts:

For the month as a whole, inflation expectations from various sources remained at a similar level to that of the previous month. Private forecasters’ inflation expectations for the next 12 CPI readings are 1.9 percent, on average. Inflation expectations for the coming 12 months derived from banks’ internal interest rates are 1.5 percent, and expectations derived from the capital market are 1.4 percent. Forward expectations for terms of 2 years and longer (monthly averages) remained stable, and range from 2.3–2.6 percent, while there was a slight decline in medium terms (4–7 years). Private forecasters’ average projections are for the CPI for September to increase by 0.2 percent. The 1-year Telbor interest rate, which reached 1.5 percent during the month, declined to about 1.2 percent at the end of the month.

Real economic activity:

Indicators which became available in the past month continue to support assessments that economic activity, excluding the effect of the start of natural gas production, continues to expand at a rate similar to that of the previous 2 years, with an increase in domestic demand offsetting a decline in exports. With that, preliminary third quarter indicators point to moderation in the growth rate of private consumption. Consumer goods imports increased in July–August by 1.8 percent compared with the second quarter, after an increase of 3.9 percent in the second quarter, and gross domestic VAT revenues (net of changes in legislation) in August were 1 percent higher than in August 2012, while in January–July they were about 10 percent higher than the corresponding months of the previous year, on average. Goods exports continued to decline, against the background of the virtual standstill in world trade, with pharmaceuticals exports notable for their stabilization at a low level. The $1.8 billion current account surplus in the second quarter was supported by growth in high technology services exports due to extraordinary transactions, and by a decline in fuel imports. The second estimate of second quarter National Accounts data indicates that the GDP growth rate moderated to 4.9 percent, compared with 5.1 percent in the first estimate. The Composite State of the Economy Index, which includes the effect of natural gas production, increased by 0.2 percent in August, and indicates that in recent months there has been a moderate but stable rate of growth. The increase in investment inputs is moderating, against the background of the investment processes in the Intel facility and in the gas industry winding up. Various surveys also indicate stability in the growth rate. The Climate Index based on the Business Tendency Survey of the Central Bureau of Statistics improved this month, though it continues to indicate a moderate rate of growth. Consumer Confidence Indices—those published by Globes, Bank Hapoalim, and the Central Bureau of Statistics—continued to indicate relatively low levels of consumer confidence, with a partial upward correction in the past two months. The Purchasing Managers Index remained unchanged in August.

The labor market: Based on labor force survey data for July, the seasonally adjusted unemployment rate declined from 6.7 percent to 6.3 percent. Original monthly data indicate that since the beginning of the year, in each month, the unemployment rate was lower than its level in the corresponding month of the previous year. The job vacancy rate declined in the past two months, and was 2.7 percent in August (compared with 2.9 percent in June), but was not significantly different than the average at the beginning of the year. Nominal wages increased by 1.8 percent and real wages increased by 0.9 percent in April–June, based on seasonally adjusted data, compared with January–March. Together with the low unemployment rate, they support the assumption that the labor market is near to full employment. Health tax receipts by the National Insurance Institute, which provide an indication of total wage payments in the economy, were 5.4 percent higher in July–August, on a nominal basis, than in the corresponding two months of the previous year, compared with a 5.1 year over year growth rate measured in the previous two months.

Budget data:

In January–August, as a result of expenditures which were relatively low compared with the path of the budget approved by the Knesset on July 30, the cumulative government deficit was NIS 7.5 billion (about 0.75 percent of GDP) below the seasonal path consistent with the deficit ceiling for 2013. If current trends remain in place, the deficit for the full year of 2013 is expected to be about 4 percent of GDP. Tax receipts, which were lower than the seasonal path in the first months of the year, were in line with the path in recent months, though the improvement halted in August. Assuming full performance of budget expenditures and preservation of the tax rates set in law, the deficit in 2014 is expected to be 3.0 percent of GDP—in line with the deficit target.

Research Department staff forecast:

This month the Research Department updated its macroeconomic staff forecast. The notice of the forecast is published concurrent with this decision. According to the revised forecast, the inflation rate in 2014 will be 1.9 percent, near to the midpoint of the target range. The Bank of Israel interest rate, which was 1.25 percent during the formulation of forecast, is expected to decline in the final quarter of 2013 to 1 percent, and then to increase and stand at 1.25 percent at the end of 2014. The GDP growth rate in 2013 is expected to be 3.6 percent (3.8 percent in the previous forecast), and excluding the contribution of natural gas production from the “Tamar” site, the growth rate is expected to be 2.6 percent (2.8 percent in the previous forecast). In 2014, GDP is expected to grow at a rate of 3.4 percent (3.2 percent in the previous forecast), and excluding the contribution of natural gas production from the “Tamar” site, GDP is expected to grow by 2.7 percent (2.5 percent in the previous forecast). The decline in the growth rate in 2014, compared with 2013, reflects primarily the smaller contribution of natural gas production to growth, as well as a decline in the growth rate of public consumption, due to a return to the path consistent with the expenditure rule, and in the growth rate of private consumption, due to the increase in taxes in 2014.

The foreign exchange market: From the monetary policy discussion on August 25, 2013, through September 20, 2013, the shekel strengthened by 2.3 percent against the dollar, and by 1 percent in terms of the nominal effective exchange rate and against the euro. Since the beginning of the year, the shekel has appreciated by 6.7 percent in terms of the effective exchange rate.

The capital and money markets: From the monetary policy discussion on August 25, 2013, through September 20, 2013, the Tel Aviv 25 Index increased by 3.8 percent, similar to the global trend. Government bond yields increased at the beginning of the intermeeting period against the background of the geopolitical tension, but for the period overall, against the background of reduced tension and the Fed’s decision regarding continued quantitative easing, yields declined. The yield differential between 10-year Israeli government bonds and equivalent 10-year US Treasury securities declined slightly, to only 110 basis points. Makam yields declined slightly along the entire curve, as the one-year yield declined during the period to only 1.15 percent. Israel’s sovereign risk premium as measured by the five-year CDS spread increased at the beginning of the intermeeting period, from 130 basis points to 147 basis points against the background of an expected US action in Syria, but after tensions calmed, it declined to 117 basis points. The Tel-Bond 60 Index increased slightly by about 0.5 percent. At the same time, spreads in the corporate bond market remained low.

The money supply:

In the twelve months ending in July, the M1 monetary aggregate (cash held by the public and demand deposits) increased by 12.8 percent, and the M2 aggregate (M1 plus unindexed deposits of up to one year) increased by 5.4 percent.

Developments in the credit markets:

The total outstanding debt of the business sector declined by 0.2 percent in July, to NIS 779 billion, primarily as a result of net repayment of tradable bond debt, while bank credit increased by about 0.5 percent. The private nonfinancial sector issued about NIS 2.5 billion in bonds in August, similar to the monthly average since the beginning of the year. Household debt increased by 1.1 percent in July, to NIS 401 billion, with an increase of 1.2 percent in households’ housing debt, to NIS 283 billion.

In August, there was about NIS 4.8 billion in new mortgages granted, compared with a monthly average of 4.4 billion since the beginning of the year. Interest rates on new mortgages remained stable in all tracks this month. Supervisor of Banks guidelines—which limit the payment to income ratio, the share of the loan which may be granted at variable rate interest, and the term until final loan repayment—came into effect and are expected to be reflected in housing credit characteristics in coming months.

The housing market:

The housing component of the CPI (based on housing rents) increased by 0.7 percent in August (a seasonal increase), following an increase of 1 percent in July. In the twelve months ending in August, this component increased by 2.7 percent, compared with an increase of 3.1 percent over the twelve months ending in July. Home prices, which are published in the Central Bureau of Statistics survey of home prices but are not included in the CPI, increased by 0.6 percent in June–July, and over the 12 months ending in July they increased by 9.3 percent, similar to the rate of change over the 12 months ended in June. There were about 43,000 building starts, cumulative, in the four quarters ending in June, compared with about 40,000 in the four quarters ending in March.

The number of transactions in the housing market continues to increase, with a decline in investors’ share of transactions.

The global economy:

The global picture indicates a possible slowdown in the rate of improvement in advanced economies, with continued moderation in emerging economy growth. The OECD slightly lowered its 2013 growth forecast for the US and China, and the World Trade Organization reduced its forecast for global trade growth—from 3.3 percent to 2.5 percent in 2013, and from 5 percent to 4.5 percent in 2014—against the background of slower than expected recovery in Europe’s economy. At the Federal Reserve, members of the Federal Open Market Committee reduced, for the third time this year, the US growth forecast for 2013, from 2.3–2.6 percent to 2.0–2.3 percent, and for 2014, from 3.0–3.5 percent to 2.9–3.1 percent. Macro data published in the US this month were mostly weak, particularly employment figures. Against the background of these developments, and against the background of the increase which occurred in bond yields and mortgage interest rates since the Fed signaled the possible beginning of tapering its bond purchase program, the Fed decided to push off the start of the process until there is additional evidence that the improvement in economic activity will be sustained. Following the decision, stock markets rose and bond yields declined. In Europe, too, macro data were mostly negative this month—the unemployment rate remained high at 12.1 percent, retail sales declined by 1.3 percent, and industrial production declined by 1.5 percent. With that, leading indicators, such as the Purchasing Managers Index, were relatively optimistic. In his monthly notice, the ECB president reiterated that the interest rate in the eurozone will remain low for a very long time. In the UK, most data surprised to the upside, but there, too, the BOE governor expressed his commitment to a low interest rate for an extended time. In Japan, most indicators signal that the economic recovery has halted. In China it appears that the economic recovery has halted, but data in most emerging markets indicate a slowdown, primarily in India and Brazil. These economies suffered from volatile capital and bond markets against the background of the uncertainty regarding the tapering process. Inflation in major economies continues to be low. Oil and commodity prices declined slightly this month, against the background of, among other things, the decline in geopolitical tension in the Middle East.

The main considerations behind the decision

The decision to reduce the interest rate for October 2013 by 0.25 percent to 1 percent is consistent with the Bank of Israel’s monetary policy, which is intended to entrench the inflation rate 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:

Inflation over the past 12 months and inflation expectations for the coming year are below the midpoint of the inflation target range.

Indicators which became available this month continue to support the assessment that economic activity, excluding the effect of the start of natural gas production, continues to expand at the moderate rate which characterized it in the past two years, and stability in the labor market continues. With that, the decline in exports, against the background of the virtual standstill in world trade, continues, and there is moderation in the growth rate of private consumption. The growth in government expenditures is expected to moderate in 2014, and in the beginning of that year additional tax increases will come into effec

The global picture indicates a possible slowdown in the pace of recovery in advanced economies, with continued moderation in growth of emerging economies. This month, the World Trade Organization reduced its forecast of trade growth, the Fed reduced its forecast for US growth, and the OECD reduced its growth forecast for the US and China. The global inflation environment continues to be low.

The Fed announced that it will continue its quantitative easing program at the current volume, until additional evidence accumulates that indicates that the improvement in economic activity will be sustained. In light of the deferral of the tapering process, the uncertainty about its precise timing, its strength, and its consequences continues. Central banks of Europe, the UK, and Japan are expected to maintain a very accommodative stance of monetary policy for an extended period of time.

With reduced geopolitical tension, and against the background of accommodative policy worldwide, there is again appreciation in the nominal effective exchange rate, with the shekel appreciating by 1.0 percent since the previous monetary discussion, and by 6.6 percent for the year to date.

Home price appreciation continues, and mortgages continued to be taken out in large volumes. However, guidelines published by the Supervisor of Banks, which limit the share of repayment out of income, the share of the loan which may be granted at variable rate interest, and the term until final loan repayment, are expected to reduce the risk to mortgage borrowers and the banking system.

The Bank of Israel will continue to monitor developments in the Israeli and global economies and in financial markets, particularly in light of the continuing uncertainty in the global economy. 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, and in this regard will keep a close watch on developments in the asset markets, including the housing market.

The minutes of the monetary discussions prior to the interest rate decision for October 2013 will be published on October 7, 2013.

The decision regarding the interest rate for November 2013 will be published at 17:30 on Monday, October 28, 2013.

(YWN – Israel Desk, Jerusalem)