Hello
all.

As
you know, the Monetary Committee decided today to continue its accommodative
monetary policy and to keep the interest rate at 0.1 percent, noting that it
intends to maintain the accommodative policy as long as necessary in order to
entrench the inflation environment within the target range. The Research
Department published its updated macroeconomic staff forecast, and I will refer
to it later on.

Since
we met here at the previous press briefing, there have been mixed developments
in the inflation environment—actual inflation continued to increase moderately,
but there was a decline in expectations. The picture of strong economic
activity that we saw at the end of 2016 is not markedly different today, and I
will expand on that later on. In the foreign exchange market, the appreciation
has strengthened, impacting both the inflation environment and activity, and therefore
there was a relatively sharp policy response through foreign exchange purchases.
Assessments of the global economy are slightly more optimistic now than they
were three months ago, though political developments in various countries
continue to be a significant cause of uncertainty.

As
such, I will expand on how the Monetary Committee views the current situation,
and on the policy and its expected effects.

In
the past year, there was a moderate increase in the inflation rate, and after almost
two years in which inflation was negative, in the beginning of 2017 the
inflation rate turned positive, though it is still below the target range. This
is despite the dissipation of the effect of factors with a one-off nature that
had acted to reduce inflation, and in effect, for the past several months
energy prices have made a positive contribution to annual inflation. In the Bank
of Israel Annual Report that was published last week, we showed that changes in
consumer behavior, such as increasing purchases via the Internet, are acting to
enhance competition and thus continue to pressure toward lower inflation. This
is a structural change of price adjustment, which is likely to last for some
time, but the experience of economies that went through similar processes in
the past has taught us that it will not impact on inflation over the long term.
The decline in inflation expectations is apparently a result, to a great extent,
of the appreciation that strengthened in recent months, and I will expand on it
later on. In contrast, among the forces acting to increase inflation are the
economy’s approaching full employment and the rise in real wages. As long as
the decline in the price of inputs continues, employers will be able to absorb
the wage increase without raising prices. This phenomenon was reflected in the
spread that opened between the change in the GDP deflator and the change in the
CPI. However, this spread has begun to close and is not expected to continue for
a long time, and then the wage increase will translate into an increase in unit
labor cost, which is expected to act to increase inflation. The increase in
inflation among our main trading partners is also expected to contribute to
higher inflation in Israel. And so, despite the very low level of short-term
inflation expectations, medium term and long term expectations are within the
target range, even if they were impacted to some extent by the processes with a
short term nature. Monetary policy, in any case, will continue to act to bring
inflation to within the target range.

Fourth
quarter National Accounts data were quite strong, though they highlighted the
need for informed analysis of data that are published. The Bank of Israel’s
assessment is that a notable portion of the high growth in the fourth quarter
was a result of higher imports of vehicles in December, at a pace that cannot
be assumed to continue throughout this year. Even net of this effect, the
economy’s growth rate is satisfactory, and indicators available to us at this
time point to the pace having apparently continued in the first quarter of 2017
(though it is likely that the growth figure that will be published for it will
be low due to the fluctuations in vehicle imports.) The labor market continues
to be robust—the increase in real wages continues, and the participation and
the employment rates are stable at a high level. The continued decline in
unemployment and stability in the job vacancy rate at a relatively high level
likely indicate that there has been a further decrease in structural
unemployment in the economy.

The
picture conveyed from the data on the global economy is slightly more
optimistic than what we have seen to date. Indicators of economic activity in
major economies were positive: there was an improvement in the growth rate of
world trade, there were increases in equity markets in Europe and in emerging
markets, and the increase in inflation in most economies continued. In the US,
the recovery in activity and the entrenchment of inflation near the target led
the Federal Reserve to again increase the federal funds rate, but the interest
rate path based on forecasts of Fed officials still reflects accommodative
policy, a sign that the recovery still needs the support of accommodative
monetary policy. Likewise, there is still uncertainty regarding the economic
policy of the new administration. In Europe, too, the recovery stands in the
shadow of political uncertainty, which declined slightly after the results of
the elections in the Netherlands. However, for now, the ECB is continuing the
very accommodative monetary policy. The trend of improvement being evident in
emerging markets as well likely points to the beginning of a trend of worldwide
recovery. Should this occur, and if the risks to continued growth of world
trade as a result of political processes do not materialize, it will be good
news for Israel’s economy.

The
appreciation in the effective exchange rate continues, and in the past quarter it
was 3.1 percent. Despite the widening of the yield gap vis-à-vis the US, the
shekel appreciated by 4.5 percent against the dollar as well. Part of the
appreciation reflects the relatively good state of Israel’s economy, reflected
in, for example, a surplus in the current account and in relatively high
growth. However, in our assessment, the sharp appreciation in recent months was
partly overappreciation, which reflects, among other things, the very
accommodative policy adopted by some central banks. In this regard, it should
be emphasized that in the US as well, despite the increase in the interest
rate, the Fed is purchasing assets each month to replace previously purchased
ones that mature. Beyond its deferring the return of the inflation rate to
within the target range, the overappreciation negatively impacts industries in
the tradable sector in a manner that is likely to be irreversible. For example,
when the transitory factors causing the overappreciation are exhausted, those
factories that were unable to stay in operation when the shekel was overappreciated
will not be able to return to operating, despite there being justification for
their operation when the exchange rate reflects equilibrium. Therefore, in
addition to the low interest rate, the Bank of Israel intervenes at times in
the foreign exchange market. As could have been seen in recent months, the
intervention is more forceful when the actual fluctuations in the exchange rate
are less in line with those derived from fundamental forces in the market, in
the Monetary Committee’s assessment. I reiterate, as I noted here three months
ago as well, there is no ceiling to the foreign exchange reserves, and the
Monetary Committee will be able to act in the foreign exchange market as much
as required by monetary policy needs.

Despite
several factors of supply and demand moving in the direction that should have
caused a cooling off in the housing market, and the two most recent
observations indicating some stability in prices, it is still too early to
conclude that the increase in prices has halted. The monthly rate of new
mortgages taken out continues to decline against the background of an increase
in mortgage interest rates, in 2016 building starts maintained a rapid pace and
there was some acceleration in building completions data, and the number of
transactions decreased. The government is taking notable steps to continue to
increase the supply of homes and it is important that it persists in that.

The
macroeconomic staff forecast presented by the Research Department to the Monetary
Committee and published today (recall that it is a conditional forecast based
on assumptions regarding exogenous variables) reflects the Department’s
assessment that the extraordinary impact of vehicle imports on growth in 2016
is not expected to continue in 2017, when growth is expected to be 2.8 percent.
However, in the basic growth rate—that is, net of the fluctuations deriving
from vehicle imports—only a moderate decline is expected, with a change in the
composition of growth: the rate of growth in private consumption is expected to
moderate, and in contrast exports are expected to recover given that the
improvement in world trade continues. This composition of growth is also expected
to prevail in 2018, when growth of 3.3 percent is expected. The paths of
inflation and the interest rate indicated in the forecast are lower than those
in the previous forecast, mainly due to the effect of the appreciation that occurred
in the exchange rate: inflation is expected to enter the target range only in
the second half of 2018, and the first increase in the interest rate is only
expected in the second quarter of 2018.

In
conclusion, monetary policy continues to act to anchor inflation within the
target range, to offset overappreciation in the exchange rate, and to support
continued growth. Until now, the impact of the relatively sharp appreciation
and the changes in consumer behavior and competition on inflation is stronger
than the impact of the increase in wages and the higher inflation worldwide, so
that despite the continued increase in inflation in the past year, it is still
expected to remain below the target for more than a year.

As
such, as I noted at the beginning of my remarks, the Monetary Committee intends
to maintain the accommodative policy as long as necessary in order to entrench
the inflation environment within the target range.

 

Happy
holiday.​