(Communicated by the Bank of Israel)

  • The economic indicators relating to the period reviewed point to continued growth in Israel’s economy, albeit at a slower pace than in the last few years. The slowdown was expected, in light of the high rate of growth in the last few years and the lower rate of unemployment than in the past.
  • The financial crisis in the US and world wide has not yet affected Israel’s economy directly, and there are no indications of the stability of financial institutions being undermined.
  • The global crisis is having an indirect effect on Israel’s economy: exports have slowed as a result of the slowdown in world growth, and domestic concern – reflected in falling consumer confidence indices – led to a slowdown in the increase of private consumption and to a sharp fall in share price indices.
  • The rise in the CPI in the last twelve months was above the upper limit of the inflation target, mainly because of the increase in world input and commodity prices, but also due to domestic inflationary pressures related to the full employment environment. These trends moderated significantly after the end of the period reviewed.

The economic data relating to the period under review, May to August 2008, show that Israel’s economic growth continued, albeit at a slower pace than in the last few years. The slowdown was expected, in light of the high rate of growth in the last few years and the full employment environment. Inflationary pressure and continued real appreciation, which halted in the period reviewed, are consistent with the assessment that the growth slowdown to a great extent expresses the convergence to full utilization of production capacity.

In the four months covered by this review, the financial crisis in the US became more severe, but there were no signs of any direct effect on Israel’s economy, i.e., of any undermining of the stability of financial institutions. In light of the further slowdown in global growth, the pace of expansion of Israel’s exports moderated, although electronics exports continued growing at a good rate, due to the sound situation of the US electronics industry. As a result of the continued rise in world input and commodity prices, albeit with many fluctuations, the terms of trade worsened, with an adverse effect on the economy.

Although in the period reviewed, as stated, no significant direct effect of the global crisis was felt in Israel, there were signs of concern that it could spread, including a decline in private consumption following persistent drops in consumer confidence indices. The sharp fall in Israel’s share-price indices, including those of banks and high-tech and real estate companies, reflected these expectations.

GDP increased by 4.2 percent in the second quarter of 2008, following its 5.6 percent increase in the first quarter, and the slowdown in expansion was evident in most industries. The Bank of Israel’s composite state-of-the-economy index rose at a moderate annual rate of 2.9 percent in the period reviewed, compared with a rate of 8.4 percent in the previous four months.

The slowdown was also reflected in a decline in the government’s tax revenues towards the end of the period reviewed, but the deficit is not expected to exceed the ceiling. Despite all the above, the slowdown was not reflected in the labor market: the unemployment rate was very low compared with its past levels, and the nominal wage rose.

The slowdown world wide and in Israel is likely to ease inflationary pressures, but over the last twelve months (September 2007 to August 2008) the CPI has risen by 5 percent, far above the upper limit of the inflation target. Inflation in May-August was caused mainly by the increase in world input and commodity prices, which was reflected in increases in energy and food prices. At the same time there were indications of domestic inflationary pressures, which is consistent with the economy being in the environment of potential GDP. In light of all the above developments, the Bank of Israel increased the interest rate four times in the period reviewed, by a total of one percentage point, in order to return inflation and inflation expectations to around the middle of the target range within about a year. The moderation of inflation expectations, the fall in commodity and energy prices, and the continued global economic crisis led the Bank of Israel to reduce the interest rate during October (outside the period covered by this review) by half a percentage point.