Background
conditions

 

Inflation
data:
The Consumer Price Index for December was unchanged, in line with the
average of forecasters’ projections. There was a seasonal increase in the
clothing and footwear component (6.5 percent), and there were declines in the
housing (0.1 percent) and food (0.5 percent) components. In 2016 as a whole,
inflation was negative, at -0.2 percent. Prices of goods (food, fruit and vegetables,
furniture, and clothing), and of transport and communication—inter alia due to
the “Open Skies” reform—were the main components contributing to the CPI decline
in 2016. Other services (housing and dwelling maintenance, education, culture
and entertainment) contributed to a moderation of the decline, as their prices
increased. Energy prices were unchanged in 2016, and the effect of
administrative price reductions reduced the CPI by 0.2 percent. Prices of components
representing tradable goods in the CPI declined by 1.7 percent in 2016, and the
prices of components representing nontradable items increased by 0.6 percent.

 

Inflation and
interest rate forecasts:
One-year inflation expectations remained essentially
unchanged. The average of private forecasters’ projections stayed at 0.6
percent, and inflation expectations derived from banks’ internal interest rates
increased slightly, to 0.4 percent. Inflation expectations derived from the
capital market declined by 0.4 percentage points, to 0.2 percent, but the
measurement of these expectations was apparently affected by seasonal factors. Second-year
forward expectations also remained unchanged, at 0.8 percent. Medium-term
expectations increased, with third-year forward expectations at 1.3 percent (compared
with 1.1 percent prior to the previous monetary policy discussion), and 3–5
year forward expectations at 1.5 percent (compared with 1.4 percent). Longer-term
forward expectations (5–10 years) were 2.3 percent (compared with 2.4 percent).
Based on the makam curve, the Telbor curve and forecasters’ assessments,
there is a high probability of an increase in the Bank of Israel interest rate to
0.25 percent in about a year.

 

Real economic
activity:
The picture of real economic activity remains positive. Second
and third quarter growth data published by the Central Bureau of Statistics
were revised upward, and the full year estimate of economic growth in 2016 is
3.8 percent, driven by private consumption, which increased by 6.1 percent, and
fixed capital formation, which increased by 10.3 percent. According to the
estimate, exports (excluding diamonds and startups) grew by just 1.4 percent, against
the background of the continued slowdown in world trade and the real
appreciation of the shekel. Several indicators support the assessment that the
economy grew by a high rate in the fourth quarter as well. The net balance of
the Companies Survey indicates high growth of business sector product. Manufacturing
exports (excluding ships, aircraft, diamonds and electronic components, in
current dollars), increased by 7 percent compared with the third quarter, and
services exports increased by 13.7 percent between January and October,
compared to the corresponding period of the previous year. The Composite State
of the Economy Index increased in December by 0.45 percent, a relatively high monthly
rate compared with that of recent years. The Index was affected by the sharp
increase in consumer goods imports (an exceptional increase in vehicle
purchases, which were brought forward to December) and by the increase in the
Industrial Production Index and in the trade and services revenue indices. The
Purchasing Managers Index, and the Consumer Confidence Indices compiled by the
Central Bureau of Statistics and by Bank Hapoalim increased in December, with
the latter at a six-year high.

 

The labor
market:
The picture conveyed by the labor market remains very positive. The
job vacancy rate stabilized at a high level—3.7 percent in December (seasonally
adjusted). Nominal wages increased in August–October by 1.0 percent, and real wages
increased by 1.1 percent, compared to the preceding three months. In the past
two years, the number of employed persons in the economy has increased at a
stable rate of about 2.5 percent. In 2015, employment growth was led by public services,
while in 2016, the business sector led the growth in employment. Health tax
receipts for October–December were 5.1 percent higher (in nominal terms) than
in the corresponding period in the previous year.

 

Budget data:
The overall deficit (excluding net credit) in government activity totaled NIS
22.1 billion in 2016, representing 1.8 percent of GDP. Total domestic
expenditure (excluding credit) was similar to the amount planned in the budget.
Tax revenues exceeded the forecast by NIS 5.8 billion, and net of legislative
changes and one-off revenues, they increased by 5.8 percent in real terms
relative to 2015. Expenditures by government ministries were 7.8 percent higher
in nominal terms in 2016 than in 2015.

 

The foreign
exchange market:
From the monetary policy discussion on December 25, 2016,
through January 20, 2017, the shekel strengthened by 0.2 percent against the
dollar, and depreciated by 0.3 percent in terms of the nominal effective
exchange rate. Over the preceding 12 months, the shekel appreciated by 6.2 percent
in terms of the nominal effective exchange rate.

The capital and money markets: From the monetary policy
discussion on December 25, 2016, through January 20, 2017, the Tel Aviv 25
Index declined by about 2.7 percent. The government bond market registered declines
of up to 5 basis points in yields along the unindexed curve and of up to 12
basis points in the indexed curve. The makam curve traded at a yield slightly
above the Bank of Israel interest rate. Israel’s sovereign risk premium, as
measured by the five-year CDS spread, remained unchanged at about 69 basis
points.

 

The money
supply
: In 2016, the M1 monetary aggregate (cash held by the public and
demand deposits) increased by 17.3 percent, and the M2 aggregate (M1 plus
unindexed deposits of up to one year) increased by 8 percent.

 

The credit
market
: The business sector (excluding banks, insurance companies and
foreign companies) issued bonds totaling NIS 4.3 billion in December—mainly in
the oil and gas industry (35 percent) the trade and services industry (33
percent) and the real estate and construction industry (24 percent)—an amount
greater than the monthly average over 2016, of NIS 3.7 billion. Business sector
issuance totaled NIS 44.4 billion in 2016, led by the construction and real
estate industry, which raised about NIS 18 billion during the year. Corporate
bond spreads (excluding banks and insurance companies) declined in December, to
an average of 2.82 percentage points. In December, a total of NIS 4.7 billion
in new mortgages was taken out, and in 2016, new mortgages taken out totaled 10
percent less than in 2015. The average interest rate on mortgages continued to
increase in December on most tracks. On the CPI-indexed, variable-rate track, the
rate increased by 0.21 percentage points. On the unindexed fixed-rate track,
the interest rate increased by 0.17 percentage points, and on the unindexed variable-rate
track, it increased by 0.10 percentage points. On the CPI-indexed, fixed-rate
track, the rate remained virtually unchanged.

 

The housing
market:
The housing component of the CPI (based on residential rents) declined
by 0.1 percent in December, similar to the decline in November. In 2016, it
increased by 1.4 percent, compared with annual increases of more than 2 percent
in recent years. Home prices increased by 0.4 percent in October–November, following
an increase of 0.9 percent in September–October. Over the 12 months ending in November,
home prices increased by 8.1 percent, compared with an increase of 8.6 percent
in the 12 months ending in October. Data for October and November indicated a
sharp decline in the number of transactions, but the figures were impacted by the
Jewish holidays and by the strike at the Israel Tax Authority, so at this point
it cannot be assessed that there was in fact a decline. The stock of new homes
available for sale continued to increase, to about 31,100 (seasonally
adjusted).

 

The global
economy:
The global economy continues to grow at a moderate pace, with a
slight improvement in the growth environment, particularly in the manufacturing
sector. In parallel, political uncertainty increased. The IMF kept its global
growth forecast unchanged—with a slight upward revision in the forecast for
advanced economies and for China and a slight downward revision in the forecast
for other emerging markets—including a recovery in world trade in the next two
years. In the US, indications that the labor market is nearing full employment
are increasing. The addition of new jobs moderated in recent months, and the
unemployment rate is stabilizing at a low level, increasing from 4.6 to 4.7
percent in December. The annual rate of increase in the average wage increased
from 2.5 percent to 2.9 percent. Private consumption continues to drive the
economy, but there are also signs of recovery in industrial production, and
improvement in the real estate market continues. Inflation is nearing the
target, in view of the dissipation of the effect of the past year’s declines in
energy prices. With that, the interest rate path expected in the markets
moderated slightly, and as of now, two increases in the federal funds rate are
expected in 2017. In Europe as well, positive momentum is apparent, particularly
in Germany, where the economy grew by 1.9 percent in 2016. Unemployment in the
eurozone remained at 9.8 percent, the lowest rate in the past seven years. Inflation
increased sharply—to 1.1 percent—affected by the increase in oil prices, but
core inflation remains lower. Political uncertainty remains high, in view of
the elections expected to take place in a number of countries this year, and
the challenges to the banking system are significant. Growth in the UK in 2016
was apparently not affected by the Brexit decision, but assessments are that
growth will slow in the coming years. There were positive data in Japan, and
activity is improving, but there are still no signs of a recovery of inflation.
In China, the slowdown in growth as part of the structural change continues,
but the accelerated increases in credit and in the outflow of capital are a
source of concern. The other emerging markets benefited from an increase in
commodity prices in the past year, but some of them are exposed to the effect
of depreciation on external debt, and to a strengthening of the forces calling
for limitations on world trade. The price of a barrel of Brent crude ranged around
$55 this month. There was a renewed increase, of about 6.3 percent, in the
index of commodities excluding energy this month.

 The main
considerations behind the decision

 

The decision to
keep the interest rate for February 2017 unchanged at 0.1 percent is consistent
with the Bank of Israel’s monetary policy, which is intended to return the
inflation rate to within the price stability target range of 1–3 percent a
year, and to support growth while maintaining financial stability. The Monetary
Committee continues to assess that in view of the inflation environment, and of
developments in the global economy, in the exchange rate, as well as in
monetary policies of major central banks, monetary policy will remain
accommodative for a considerable time.

 

Following are
the main considerations underlying the decision:

 

·        
The CPI for December was
unchanged, in line with expectations. The inflation rate was negative in 2016,
but is on an upward trend. The direct effect of administrative price reductions
is dissipating, and energy prices remained unchanged, as measured over the
preceding 12 months. The low rate of inflation reflects the effect of the
appreciation, and possibly structural change and enhanced competition in the
economy. Short-term inflation expectations are below the target, while longer
term expectations derived from the capital market remain anchored near the
midpoint of the target range.

·        
The picture of real
economic activity remains positive. The Composite State of the Economy Index
increased by 0.45 percent in December, and the Net Balance in the fourth
quarter Companies Survey indicates high growth of business sector product.
Foreign trade data indicate a recovery of manufacturing exports, after a
prolonged decline since 2014. The picture conveyed by the labor market remains
very positive, and the increase in employment and wages was led by the business
sector in the past year.

·        
The global economy
continues to grow at a moderate pace. The IMF revised its growth forecast for
advanced economies and for China upward, and expects a recovery in world trade
in the next two years. With that, political developments in some advanced
economies are likely to weigh further on trade growth. In the US, the
improvement in activity continued, inflation is nearing the target and market
assessments are that the federal funds rate will be increased twice in 2017.
Nonetheless, there is uncertainty regarding the expected economic policy. In
Europe, the recovery is less entrenched, and accommodative monetary policy
continues, with political uncertainty remaining high.

·        
From the monetary policy
discussion on December 25, 2016, through January 20, 2017, the shekel strengthened
by 0.2 percent against the dollar, while it depreciated by 0.3 percent in terms
of the nominal effective exchange rate. The shekel has appreciated by 6.2 percent
over the past 12 months in terms of the nominal effective exchange rate,
against the background of a 6.7 percent appreciation vis-à-vis the euro. The
level of the effective exchange rate continues to weigh on the development of
goods exports.

·        
Home prices continue to rise
rapidly, despite a high level of unsold new homes, a decline in monthly mortgage
volume, and a continued increase in mortgage interest rates.

 

The Monetary
Committee is of the opinion that the risks to achieving the inflation target remain
high, yet the increases in wages and in global inflation are expected to
support the return of inflation to the target. The Bank of Israel will continue
to monitor developments in the Israeli and global economies and in financial
markets. 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 continue to 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 February 2017 will be published on February 6, 2017.

The next decision regarding the interest rate will be
published at 16:00 on Monday, February 27, 2017.​