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The Bank of Israel reduces the interest rate for July 2012 by 0.25 percentage points to 2.25 percent
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Inflation data:The Consumer Price Index (CPI) was unchanged in May, below the seasonal path consistent with achieving the inflation target and below forecasts which were for an increase of 0.20.3 percent. The surprise in the CPI was due mainly to the food component, which declined by 0.4 percent compared with a forecast for a moderate increase. The rate of inflation over the previous twelve months declined to 1.6 percent, below the center of the inflation target range (13 percent).
Inflation and interest rate forecasts: Inflation forecasts, excluding those calculated from the capital markets, declined this month. Inflation expectations calculated from the capital markets (break-even inflation) remained at their level of the past two months, 2.12.2 percent. The average of forecasters' projections of the CPI for the next 12 readings declined after the release of the May CPI, from 2.2 percent to 2 percent. Inflation expectations based on over-the-counter CPI futures contracts offered by banks declined this month, particularly after the May CPI was published, from around 2.3 percent to 1.8 percent. Inflation expectations for medium terms declined as well, by 0.2 percentage points, to 2.4 percent. Expectations for longer terms were stable at 2.5 percent. Expectations for the Bank of Israel interest rate derived from the Telbor (Tel Aviv Inter-Bank Offered Rate) market and as calculated from the makam yield curve indicate a 0.25 percentage point decline in the interest rate during the next three months. Most forecasters predict that the Bank of Israel interest rate for July will be reduced by 0.25 percentage points.
Real economic activity: Most indicators of real economic activity that became available this month point to a continuation of growth at a moderate rate of around 3 percent on an annual basis. The second estimate of National Accounts data for the first quarter indicates that GDP grew by 2.9 percent and that business sector product grew by 2.6 percent. Figures for imports and exports were mixed: data on goods exports (excluding ships and aircraft and diamonds) for May indicate a slight decline in exports compared with the previous month, while services exports (seasonally adjusted) increased in April by about 6 percent compared with March, continuing the increase in the first quarter of the year. Goods imports (excluding ships and aircraft and diamonds) increased in May by about 1 percent. Most monthly indicators point to continued growth at a moderate ratethe Composite State of the Economy Index for May increased by 0.2 percent, and the indices for the previous two months were revised upward; the climate indices for May, based on the Central Bureau of Statistics Business Tendency Survey, indicate stability in the growth rate of the business sector; and the Consumer Confidence Indicator calculated by the Central Bureau of Statistics increased moderately in May, following its moderate increase in April. The Purchasing Managers Index declined in May by 2.2 points, but for the second consecutive month the index was above 50 points, the boundary between growth and contraction. The Research Department's index based on Google searches, which serves as an indicator of demand in the economy in the coming months indicates a high probability of acceleration in trade and services revenue in June.
The labor market: Labor market data which became available after the last monetary policy discussion indicate continued improvement in this area. April data from the monthly Labour Force Survey indicate an increase in the participation rate to 63.2 percent and in the employment rate to 59 percent. The unemployment rate in April declined slightly to 6.7 percent. Figures on employee posts for March indicate an acceleration in the trend of increase in employee posts. The forecast for the number of employees, derived from the Business Tendency Survey, is for an increase in employee recruitment in the coming months. Health tax receipts, which provide an indication of total wage payments, were 5.1 percent higher in May in nominal terms than in May 2011 (excluding the effect of legislative changes); in contrast, April receipts were 6.5 percent higher than in April 2011. Nominal wages declined by 0.1 percent in JanuaryMarch compared with the preceding three months, and real wages declined by 1.1 percent.
The Bank of Israel Research Department staff forecast: The Bank of Israel Research Department updated this month its macroeconomic forecast for 2012 and 2013. (A separate release, presenting the forecast, is published in parallel with this interest rate release.) The forecast for the primary variables was revised downward, though only slightly so. Projected GDP growth in 2012 was unchanged at 3.1 percent. In light of the decline in the global growth forecast, the forecast for 2013 for Israel declined slightly to 3.4 percent from 3.5 percent in the previous forecast. (The Research Department also presented a scenario in which the interest rate remained unchanged. Under this scenario, the forecast was for 3.3 percent growth). According to the staff forecast, the inflation rate over the 4 quarters ending in the second quarter of 2013 is expected to be 2.4 percent. The Research Department forecasts that following the current interest rate reduction, the interest rate will remain unchanged until at least the end of 2013, while the previous forecast projected that the interest rate would begin to increase toward the end of 2013. The current forecast was influenced by the deterioration of the economy in Europe, but at the same time also by domestic data for the first half. The Research Department noted that the main risk to the forecast is a deterioration of the financial crisis in Europe.
Budget data: Actual budget expenditure resulted in a domestic deficit from the beginning of the year through May of NIS 2.9 billion, compared with a surplus of NIS 0.7 billion in the corresponding period of 2011. In accordance with the revised growth forecast, the deficit in 2012 is projected to be about 3.7 percent of GDPabove the seasonal path consistent with the Ministry of Finance's revised deficit forecast of 3.4 percent of GDPprimarily due to tax receipts below the path expected for JanuaryMay. The government's commitments for this year (wage agreements, defense expenditure, etc.) are significantly above the budget's expenditure ceiling. It should be noted, however, that the government has not in the past deviated from the budget expenditure framework.
The foreign exchange market: From the previous monetary policy discussion held on May 23, 2012, through June 21, 2012, the shekel depreciated against the dollar by about 1.2 percent, and depreciated by 0.32 percent against the euro, in line with the trend of most currencies against the dollar and euro. In terms of the nominal effective exchange rate the shekel depreciated by about 0.87 percent.
The capital and money markets:From the previous monetary policy discussion held on May 23, 2012, through June 21, 2012, the Tel Aviv 25 Index increased by 2.7 percent, in line with the worldwide trend. In the unindexed bond curve, yields declined 2030 basis points along most of the curve, which steepened. A similar trend was observed on the CPI-indexed bond curve, with declines of 1020 basis points. The yield gap between Israeli 10-year government bonds and equivalent 10-year US Treasury securities was stable this month, with a slight decline of 4 basis points, to 271 basis points. Makam yields declined by about 20 basis points along the entire curve, with one year yields at 2.19 percent during the period. Israel's sovereign risk premium as measured by the five year CDS spread declined by about 20 basis points this month to 170 basis points, similar to developments in many emerging economies. The Tel-Bond 20 Index declined by about 1.1 percent, and the Tel-Bond 40 Index declined by about 1 percent. This was part of the negative domestic trend, which was reflected in, among other things, a widening in Tel-Bond yield gaps vis-?-vis government bonds and in increased yields of holding groups.
The money supply: In the twelve months ending in May, the M1 monetary aggregate (cash held by the public and demand deposits) increased by 2.5 percent, and the M2 aggregate (M1 plus unindexed deposits of up to one year) increased by 6.9 percent.
Developments in the credit markets: The outstanding debt of the business sector increased in April by 0.5 percent, to NIS 790 billion. The increase in the debt derived primarily from the increase in the CPI and the depreciation of the shekel. These factors increased the balance of CPI-indexed debt and of foreign currency denominated debt. Company responses to the Central Bureau of Statistics Business Tendency Survey indicate that companies in nearly all industries sense an easing in the credit constraints they face, except for the construction and hotels industries, where firms reported that the credit constraint became more severe, although the constraint was reported to be moderate. Total outstanding credit to households increased in April by 0.2 percent, to NIS 368 billion, within which the balance of outstanding housing credit was NIS 263 billion. Total mortgages granted in the twelve months ending in May were 1.7 percent lower than those advanced in the twelve months to April, continuing the decline from the peak level in May 2011. Unindexed floating rate mortgages granted in May constituted 28 percent of total new mortgages. Interest rates on indexed mortgage tracks declined by 0.1 percent this month on average, and interest rates on unindexed mortgages were unchanged.
The housing market: The housing component of the CPI (representing rents) increased in May by 0.3 percent. In the twelve months ending in May it increased by 3.8 percent, compared with an increase of 4.6 percent in the twelve months to April. Home prices, which are published in the Central Bureau of Statistics survey of home prices but are not included in the CPI, increased in MarchApril by 1.4 percent, after remaining relatively stable in DecemberMarch. In the twelve months to April, home prices increased by 2.2 percent, similar to the rate in the twelve months to March. Activity in the construction industry is strong compared with its levels in the past decade. Although building starts are below the record level of the middle of 2011, they remain high and are expected to continue to be reflected in an increased inventory of homes. There were 43,770 building starts in the twelve months to March, compared with 44,817 in the twelve months to February. In FebruaryApril, the stock of vacant homes available for sale remained stable at 20,500, after a trend of increase in the past year.
The global economy: There was an additional deterioration in economic developments in Europe this month, along with further signs of a slowdown in the global economy's growth rate. In Europe, purchasing managers indices as well as indices of manufacturing, employment, and sales indicate a slowdown. The unemployment rate in the EU reached a record 11 percent; Spain's unemployment rate of over 24 percent was notably poor. In the US, most economic figures indicate a slowdown, reflected primarily in the labor market and in personal consumption expenditure. The Tech Pulse Index continued to indicate a recovery, and a slight recovery was seen in the real estate market. In the large emerging market economiesChina, India, and Brazildata continued to emerge indicating a marked slowdown in growth rates. Investment houses revised downward their growth forecasts for major economies in the world. Against the background of the crisis in Europe, there was a steep increase this month in yields on Spain's sovereign bonds to over 7 percent. Globally, the inflation environment is expected to remain low in advanced economies, and to continue to moderate in developing economies that are experiencing a marked slowdown in growth. Commodity prices continued to decline this month as well, a trend which was prominent primarily in oil prices, which declined by about 15 percent. Against the background of these developments, central banks again extended various easing plans. The Fed extended its Operation Twist, in which it sells short term securities and buys long term bonds to replace them, until the end of the year. The Bank of England also reported the implementation of aid programs for the real and financial sectors. The ECB adopted various expansionary measures as well, including a decision on a 100 billion loan to Spain, with the aim of injecting capital into that country's banking system. Likewise, there are expectations for additional significant measures by the EU at the end of the month. Against this background, stock market indices rose around the world and there was a decline in the yield on Spain's sovereign bonds. Interest rate reductions continued in several countries.
The main considerations behind the decision
The decision to reduce the interest rate for July 2012 by 0.25 percentage points to 2.25 percent is consistent with the Bank of Israels interest rate policy that is intended to entrench the inflation rate within the price stability target of 13 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, the global economy, monetary policies of major central banks, and developments in the exchange rate of the shekel. The interest rate reduction will contribute to strengthening the Israeli economy's ability to deal with the impact of potential negative consequences from the global economy.
The following are the main considerations underlying the decision:
  Following the May CPI, actual inflation over the previous 12 months is below the center of the inflation target range, and inflationary pressures are not felt. Various inflation expectations for the coming 12 months are around the center of the target range, after inflation expectations of forecasters and those based on over-the-counter CPI futures contracts were revised markedly down. Prices of commodities, particularly oil, declined sharplya continuation of their declines in the previous two months.
  Most indicators of real economic activity in Israel which became available this month point to continued moderate growth at an annual rate of 3 percent, a rate similar to that of the first quarter. After the reduction in the interest rate for July, the Research Department staff forecast for GDP growth in 2012 remains 3.1 percent and the forecast for 2013 was revised to 3.4 percent.
  This month macroeconomic data around the world indicate a further slowdown in growth, and projections of international organizations were revised downward. The level of economic risk in the world due to developments in Europe remained high, and with it the concern of negative effects on the domestic economy.
  Interest rates in the major economies remain low, and markets are not pricing in any increases in interest rates this year by any of the leading advanced economies' central banks. Several central banks even reduced interest rates this month. Against the background of recent developments, the Fed announced the continuation of its easing plans, and there are increasing market assessments that several central banks will take additional easing steps.
The Bank of Israel will continue to monitor developments in the Israeli and global economies and in financial markets, particularly in light of the increasing 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.
The minutes of the discussions prior to the above interest rate decision will be published on July 9, 2012.
The decision regarding the interest rate for August 2012 will be published at 17:30 on Monday, July 23, 2012.