To the report​

of recent economic developments


Monetary policy: In the second half of 2016, the Monetary Committee left the
benchmark rate unchanged at 0.1 percent, and continued to assess that monetary
policy would remain accommodative for a considerable time. During the reviewed period, however, the Committee
expressed the view that it is no longer needed to examine the use of various monetary
tools. Within the framework of monetary policy, the Bank of Israel continued to
purchase foreign currency, buying $2.6 billion during the reviewed period. The
Committee preferred to make use of foreign exchange market intervention, rather
than a further reduction in the interest rate, because of the risks inherent in
a negative interest rate policy. In September, the Committee decided to reduce
the frequency of interest rate decisions from twelve to eight per year, from
2017 onward.


Inflation and inflation
In the twelve months
ending in December 2016, the Consumer Price Index declined by 0.2 percent.
During the review period, the annual inflation rate increased, as the direct
effect of declines in energy prices and of government-initiated price
reductions dissipated. One-year inflation expectations and one year, one-year
forward expectations (that is, second year forward expectations) continued to
range below the lower bound of the inflation target. Forward expectations for
medium terms were above the lower bound, and forward expectations for longer
terms (5–10 years) remained anchored at around the midpoint of the target


Domestic real activity: Revised National Accounts data for the second and third
quarters indicated that the economy is growing by a more rapid rate than had
been previously published, driven by private consumption and fixed capital
formation—components that continued to be supported by low interest rates.
Throughout the second half, growth data were adjusted upward markedly, and the
first estimate of full-year year data from the Central Bureau of Statistics
showed 3.8 percent growth in 2016. In discussions on the interest rate for
September, the committee members expressed the view that given the large
increase in the first-quarter growth estimate, the risks to growth had
diminished. The labor market continued to display resilience and the
unemployment rate remained low; these developments were reflected in wage
increases and in the number of job vacancies.


Exchange rate: During the review period, the shekel appreciated in
nominal effective exchange-rate terms, primarily due to depreciation against
the euro against the background of the eurozone’s continued monetary accommodation and low growth environment.
Conversely, the dollar maintained its value against the shekel and appreciated
against most currencies worldwide. For the period overall, the shekel
appreciated by 5.2 percent against the currency basket (June average vs.
December average). The appreciation continued to weigh on the continued growth
of goods exports. Various equilibrium exchange-rate models that were presented
to the Monetary Committee indicate that
the shekel is overvalued. The Monetary Committee
assesses that a significant share of the appreciation is based on enhanced
monetary accommodation worldwide, particularly negative interest rates and
quantitative easing programs in Europe and Japan. This accommodation forced
several countries (such as Sweden and Switzerland) to adopt similar policy, and
in other countries central banks had to reduce the interest rate and intervene
in the foreign exchange market to prevent further currency appreciation that
would negatively impact exports. The main objective of the intervention policy
is to moderate the effect on the economy of the atypical monetary accommodation
of Israel’s trading partners, without necessitating the extreme means adopted
by Europe and Japan.


Global economy: The growth rate of global economic activity remained
moderate during the second half of 2016; concurrently, the forecasts of leading
international entities, for both global growth and world trade, were revised
downward. These entities also assessed that the risks to the forecasts tended
to the downside. The revision of these forecasts was influenced by unforeseen
developments in the global economy: the results of Britain’s referendum in
favor of Brexit and the increase in political uncertainty. Oil prices held
steady during most of the period after rising sharply in the previous
half-year, and they moved up again toward year’s end. In parallel, bond yields
increased sharply in major bond markets and inflation expectations increased in
the medium to long terms. Monetary policy remained markedly accommodative in
most major markets, and became even more accommodative in most of them.
Conversely, the US Federal Reserve decided in December to raise its benchmark
rate to 0.5–0.75 percent. According to the median estimate among members of the
FOMC, the pace of rate-hiking will be slightly faster than previously assessed.


Housing market: Home prices continued to rise in the second half of
2016. New mortgage volume declined from the record reached at the beginning of
the year but the number of transactions remained high. Mortgage interest rates
continued to increase and the spread over government-bond interest rates
continued to widen in view of the upturn in risk in the banking system’s
housing-credit portfolio, an increase in the cost of the sources that the banks
raise, and previous measures by the Banking Supervision Department to mitigate
risk to borrowers and banks. The stock of homes available for sale continued to
grow in the half-year reviewed, reaching a record level. The annual rate of
increase in housing rent declined slightly toward the end of the review period.


Financial markets: Domestic equity indices remained essentially unchanged
during the review period (in dollar terms, December average vs. June average),
similar to the leading indices in Europe and in emerging markets and in
contrast to US indices, e.g., the S&P 500, which continued its rally seen
in the preceding half year. Domestic nominal and real yield curves increased
for medium and long terms, as did curves abroad—consistent with the stability
that medium- and long-term inflation expectations have been displaying. The
spreads between corporate bonds and similar government bonds remained stable in
the second half of 2016.


Fiscal developments: The cumulative domestic deficit (excluding net provision
of credit) was NIS 20.7 billion in July–December 2016, compared with
NIS 18.8 billion in the corresponding period a year earlier (constant
prices). The annual deficit was 2.1 percent of GDP, markedly lower than the
target (2.9 percent) and similar to the 2015 deficit. The deviation from the
original budget forecast reflects higher revenues—from taxes and from surpluses
on National Insurance Institute activity—as total expenditures largely adhered
to the original budget. Total tax revenues in 2016, net of legislative changes
and timing differentials in respect of vehicle imports, increased by 5.5
percent relative to the previous year, similar to the growth rate of nominal
GDP. The share of public debt in GDP declined to 61.9 percent.


Research Department
In the forecasts that it
formulated toward the end of December 2016 (before the Central Bureau of
Statistics released its full year estimate), the Research Department estimated
GDP growth in 2016 at 3.5 percent (as against 2.8 percent in the previous
forecast), and projected growth of 3.2 percent in 2017 and 3.1 percent in 2018.
According to the forecast, inflation is expected to converge gradually to
within the target range in the next few quarters, reaching 1 percent of the end
of 2017 and 1.5 percent in 2018. The Bank of Israel benchmark rate, according
to the forecast, is expected to stay at its current level until the third
quarter of 2017 and to increase to 0.5 percent at the end of 2018.​