Hello
all.

As
you know, the Monetary Committee today decided to continue its accommodative
monetary policy and keep the interest rate at 0.1 percent. The Research
Department published its updated macroeconomic staff forecast, which includes
for the first time a forecast for 2018 as well, and I will refer to it later
on.

The
previous time we met here, the inflation environment was still very low, but we
assessed that the improvement in the real economy continued in the third
quarter, and that in fact turned out to be the case when data for the quarter were
published. The US elections were a great unknown to us at the time, and now too
there are various assessments regarding the medium and long term ramifications
of the results, though the short-term impact on financial markets has already
been seen.

The picture
being conveyed to us at this time is that the economy continues to grow at a
solid pace and the labor market is strong, while the inflation environment
remains very low.

In
recent months, the direct effects of administrative price reductions and the
decline of energy prices on inflation have begun to dissipate. The annual rate
of inflation has begun to increase slowly, though the increase halted in the
November CPI reading. Although energy prices have had virtually no direct impact
on the CPI over the preceding 12 months, and despite the effect of
administrative price reductions having been nearly exhausted, wage increases
are still not leading to an increase in inflation. It is likely that the
decline in commodity prices that occurred through the end of 2015 still enables
manufacturers to absorb the wage increase, though in recent months commodity
prices have again begun to increase. It is also likely that structural processes
of increasing competition, and possibly exposure to private imports via the
Internet as well, for the time being are also delaying an increase in prices. The
low inflation is also partly the result of the effective appreciation. In any
case, it is clear that inflation remaining low does not derive from low demand,
as it is occurring in tandem with solid growth in private consumption, a labor
market near to full employment, and wage increases. Short term expectations are
still low, and to some extent declined due to the surprise to the downside in
the November CPI reading. It also impacted somewhat on some medium and long
term inflation expectations, which have increased since the US elections, and
continue to be anchored within the target range.

In
the third quarter, as noted, economic activity continued to grow at an adequate
pace, and the indicators we see enable us to assess that the economy continued
to increase at an adequate pace in the fourth quarter as well, supported by the
accommodative monetary policy. Growth in 2016 was based primarily on private
consumption and investment. Consumption was impacted on by the high rate of
growth in employment and wages, as well as by the low interest rate.
Investment, which increased by more than the investment in vehicles, will
increase the future production capacity of the business sector. There are two
separate trends in exports: services exports returned to growth at a solid
pace, while goods exports, which grew in the second quarter, returned to contraction
in the third quarter, so that over time it has been at a virtual standstill,
against the background of weakness in world trade and the effective
appreciation of the shekel. It is important to recall that export industries
are productivity drivers of the Israeli economy, and the ability of exports to
recover will allow Israel’s economy to benefit from healthier growth over time.
The two-year budget that was approved in the Knesset last week is somewhat expansionary,
as it aims at a deficit target higher than this year’s, and therefore will
provide support for growth in the short term. Labor market strength continues
to be reflected in all parameters of wage and employment.

The
global economy continues to grow by a moderate rate, with major blocs moving in
contrasting directions. In the US, growth improved in the second half of the
year, the labor market is in a good state, and inflation is approaching the
target. Following the surprising US election results, market developments were also
not what was expected beforehand, and so far are reflected in an increase in
yields, an increase in stock market indices, and marked strengthening of the
dollar. All these enabled the Federal Reserve, as expected, to increase the
federal funds target rate by one-quarter of a percentage point, and it signaled
an interest rate path that is slightly higher than what was assessed to date.
In contrast, in Europe the recovery is slow, and its economy faces numerous
political risks. The ECB extended the horizon of its quantitative easing this
month, and the euro continues to weaken markedly. Israel’s economy is very
affected by developments in both the US and Europe. Weakness in Europe and the
weakness of the euro negatively impact on goods exports, for which Europe is a
main destination; the recovery in the US, to the extent that it persists, will
be good news for the global economy overall, and for Israel’s economy in
particular. However, in various countries worldwide there are continuing
processes that are likely to lead to a trend of increased restrictions on world
trade; these processes are expected to negatively impact the global economy
overall, and in particular small and open economies such as Israel’s.

The
appreciation in the effective exchange rate continues, and over the past year
it was more than five percent. Against the dollar, the shekel fluctuated
without a trend in the year, despite the strengthening of the dollar worldwide,
and it may be assessed that the interest rate gap expected to open between the
dollar and the shekel is expected to act toward the shekel’s weakening against
the dollar. In contrast, the depreciation of the euro, the pound sterling and other
currencies less significant in terms of Israel’s trade impacted on the exchange
rate of the shekel against those currencies, a process that reflects partly the
Israeli economy’s performance being markedly better than other economies, and
partly the aggressive monetary accommodation adopted by some central banks. In
either case, the appreciation weighs on Israeli exports.

The
Bank of Israel’s policy in the foreign exchange market is not intended to act
against fundamental forces, but it does moderate the forces for appreciation
and buys time for exporters to make the adjustments for long term changes in
export markets, which at times are seen rapidly in the currency markets. Thus,
the policy supports the recovery of exports, and is an integral part of
monetary policy.

In
the housing market as well there are trends moving in opposite directions. The
pace of building starts returned to increase, and in the past year, according
to updated figures, there were more than 50,000 building starts; the supply of
unsold homes is at record levels, and the number of transactions is declining,
with an emphasis on purchases by investors. The increase in mortgage interest
rates led to a moderate but continued decline in monthly volume of new
mortgages. All these are forces that are expected to act toward moderation of
prices, but so far prices continue to increase at a relatively rapid rate. The
duration of construction becoming longer, and building completion data not
maintaining the pace of building starts, is troubling, and the government will
need to continue working intensively to persist in increasing supply.

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) incorporates a
more optimistic estimate in terms of 2016 growth, in view of what retroactively
turned out to be first half growth that was higher than known at the time the
previous forecast was compiled, and in light of the strong third quarter
data—the assessment is that the economy grew by 3.5 percent in 2016, by 3.2
percent 2017, and in 2018, for which this is the first forecast, by 3.1
percent. The interest rate and inflation paths are similar to those in the
previous forecast—the Research Department continues to assess that the interest
rate will begin to rise by a slow rate at the end of 2017. According to the
forecast, inflation is expected to reach the lower bound of the target range in
about a year.

In
conclusion, in the fourth quarter as well, monetary policy acted against the
background of several processes whose impacts on the policy are not uniform.
While economic activity in Israel is becoming entrenched, and the labor market
continues to show strength, the inflation environment is still low and the
inflation rate is markedly lower than the target. Political processes in
various countries worldwide continue to impart uncertainty regarding expected
developments in the global economy, and the divergence in monetary policy
between the US and other major economies is widening. Against the background of
these factors, the appreciation in the effective exchange rate is continuing.
The picture that is becoming apparent is that in terms of real activity, the
Israeli economy’s business cycle is more in line with that of the US economy;
in contrast, the picture of inflation in Israel is similar to that in Europe. It
is important to note that the Bank of Israel’s monetary policy does not
necessarily move in line with what is occurring in a specific economy, but is
established through analysis of the range of developments and their impact on
the Israeli economy and financial markets in Israel.

The
Monetary Committee assesses that monetary policy will remain accommodative for
a considerable time, in order to support the return of inflation to within the
target range. The policy of foreign exchange purchases will continue, as
necessary, to support the attainment of policy goals.

It
turns out this year that we hold these press briefings at festive times of the
year. Our previous meeting was on the eve of the Jewish New Year (Rosh Hashana),
and our next meeting will be around the eve of Passover.

Until
then, Happy Chanukah to all!​