Hello
all.

As
you know, the Monetary Committee decided today to keep the interest rate at 0.1
percent, and reiterated 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, the inflation environment has been somewhat
volatile, but remains below the target range. The picture of economic activity remains
strong. The rate of appreciation in the nominal effective exchange rate
moderated, with significant intervention by the Bank of Israel, but the
exchange rate is appreciated. Moderate recovery continues in the global
economy, but the extremely accommodative monetary policy still continues in
Europe, Japan, and other economies. I will now expand on these developments and
how they are expected to impact on policy.

In
the past year, there was a moderate increase in the inflation rate, and in
recent months it stabilized slightly below the target range. The higher
inflation worldwide and domestic wage increases are contributing to the
increase of inflation, but countering that, the shekel appreciation, the halt
in the increase in energy prices, government measures to reduce the cost of
living, and changes in consumer behavior and in competition in the economy are moderating
the inflation rate. These are expected to lead to the annual inflation rate declining
over the coming months, before returning to rise toward the target range.
Despite the increase in recent months in short term expectations, they are
still lower than the target, and are apparently impacted to a great extent by
the appreciation in the exchange rate—thus it is likely that its impact on
inflation has not yet been exhausted. Medium term and long term expectations fluctuated
within the target range throughout the period, so market participants do not
doubt the credibility of the inflation targeting regime, but are of the opinion
that it will take time until the processes that I described are exhausted and
annual inflation will return to the target range.

Economic
activity continues to grow at a satisfactory rate. Net of the atypical effect
of fluctuations in vehicle imports, the economy has been growing for the past
year and a half by approximately 4 percent per year, and recent indicators
enable us to assess that this growth will be reflected in second quarter data
as well. After a long period in which private consumption drove growth, there
are increasing signs that at this time there is a return to more balanced
growth in the economy, with both exports and investments contributing. The effect
of the appreciated exchange rate is seen mostly in goods exports, while
services exports are growing at a solid pace. Over time, against the background
of the appreciation, goods exports were weak compared with the increase in
world trade, while services exports increased by a rate faster than that of global
growth in services. The unemployment rate is very low—both from a historical
perspective and in international comparison—and the slight increase seen in the
most recent data is the result of an increase in the participation rate, and
not from a shortage of workplaces. On the contrary—many industries are actually
reporting a shortage of workers, as evidenced by the high level of job
vacancies.

In
the past half year, home prices stabilized, and a range of housing market data
indicate that the market is cooling off: the decline in the number of
transactions continues, and the monthly pace of new mortgages taken out moderated,
even though the increase in mortgage interest rates was halted. Government
efforts to continue to increase the supply of homes will support the
stabilization of prices and subsequently their reduction.

In
the global economy, the moderate improvement that we’ve seen in recent months
continued. Forecasts for global economic growth have generally been revised
upward recently, and the improvement in the growth rate of world trade continues.
The positive momentum was notable in Europe against the background of political
developments that reduced the risk to the continued existence of the eurozone
and the EU; growth there is becoming entrenched, with continued decline in
unemployment, though inflation remains lower than the target. In the US, an
improvement in growth is apparent, after first quarter growth disappointed, but
there is uncertainty about the government’s ability to implement the economic
plans it announced. The Federal Reserve increased, as expected, the federal
funds target rate by one quarter of one percentage point, and the pace of
future increases is expected to be moderate; the Fed also revealed the details
of the program through which it will begin the process of reducing its balance
sheet, but did not set a specific date for its start. In Europe and in Japan,
the very accommodative monetary policy continues. Financial markets interpreted
the ECB’s messages as an indication that the extent of the monetary
accommodation is expected to contract, and this was reflected in increased
yields on government bonds. With that, the ECB did not give an indication regarding
the timing of when it will begin to retreat from the quantitative easing.

After
the sharp appreciation in the effective exchange rate over the first few months
of the year, the pace of the appreciation moderated: over the past three
months, in which the Bank of Israel purchased approximately $3 billion in
foreign exchange, there was a nominal effective exchange rate appreciation of
one percent, with a relatively sharp change in cross exchange rates—the shekel
appreciated against the dollar during this period by more than 3 percent, but
weakened against the euro by about 3.5 percent. As we have said in the past,
the level of the exchange rate partly reflects the relatively good state of
Israel’s economy, reflected in, for example, the current account surplus and
relatively high growth. However, in our assessment as well as that of other
entities in the market, the shekel is overvalued, a result of the very
accommodative policy that some central banks are adopting. The level of the
exchange rate weighs on exports, with an emphasis on manufacturing and on the
tradable industries in general. Over time, in order to support these
industries, the government should adopt policy measures that will increase
productivity: improve the business environment, improve human capital, and
increase the investment in infrastructure (which in itself, as we showed in the
Bank of Israel Annual Report, can contribute to a depreciation in the exchange
rate).

The
continued monetary contraction in the US, and a change in the trend of very accommodative
monetary policy in Europe and in other economies, when it occurs, will on their
own serve as a force for the weakening of the shekel. However, the Monetary
Committee will act in the foreign exchange market as long as monetary-policy needs
warrant it.

The
Research Department presented the macroeconomic staff forecast (recall that it
is a conditional forecast based on assumptions regarding exogenous variables) to
the Monetary Committee, and published it today. In light of the high growth in
recent quarters, the 2017 full-year forecast was revised upward, to expected
growth of 3.4 percent, similar to the 3.3 percent growth forecast for 2018. The
forecast has been revised upward regarding the growth rate of exports over the
coming two years, in view of the improvement in world trade. Inflation is
expected to enter the target range in approximately a year, although, as noted,
it is expected to decline further before returning to rise. The interest rate
path in the forecast is the same as what was presented in the previous
forecast.

In
conclusion, the Bank of Israel’s monetary policy is influenced by developments in
the global economy, but it is only directed toward achieving domestic targets.
In our assessment, the accommodative policy contributed to the economy growing at
a satisfactory pace and to the especially low unemployment rate. With that, for
the various reasons I noted, inflation remains below the target, and even if additional
central banks will begin to reduce their monetary accommodation, the Monetary Committee
intends to maintain the accommodative policy as long as necessary in order to
entrench the inflation environment within the target range.

 

Have
a nice summer!​