By CentralBankNews.info
The Bank of Israel (BOI) kept its key interest rate unchanged at 0.1 percent, saying the sharp drop in inflation was not due to a fall in demand but rather due to the method for measuring prices of clothing and footwear along with the accumulated impact of a rise in the shekel’s exchange rate and increased competition that has curbed price hikes in some industries.
The BOI, which has maintained its rate since March 2015, also repeated its guidance that it would maintain its current accommodative policy “as long as necessary in order to entrench the inflation environment within the target range.”
Israel’s inflation rate fell to minus 0.7 percent in July from minus 0.2 percent in June – well below the BOI’s 1 -3 percent target range – pushing down one-year inflation expectations but medium and long-term expectations remain stable.
“The wage increases in the economy and the change in the trend of the exchange rate, to the extent that it persists, will support inflation, while the effect of additional initiated price reductions and the moderation of inflation worldwide act to reduce inflation,” BOI said.
Supported by an improving global economy and world trade, Israel’s services sector is expanding strongly although initial estimates for overall growth in the first half of this year show a slowdown compared with accelerated growth in 2016 as goods exports are affected by the strong shekel.
Israel’s Gross Domestic Product grew by an annual rate of 2.9 percent in the second quarter, down from 3.6 percent in the first quarter, with the BOI last month raising its 2017 growth forecast to 3.4 percent from 2.8 percent.
“The most recent data indicated continued growth of economic activity at a similar rate in the beginning of the third quarter,” BOI said.
After steadily rising since March 2015, the shekel has lost some steam since July, with the BOI saying it depreciated by 3.2 percent in nominal terms since its previous policy meeting on July 10.
But compared with the start of this year, the shekel is still up by 4.1 percent in terms of the effective exchange rate, it added.
The shekel was trading at 3.58 to the U.S. dollar today, up 7.5 percent this year.
The Bank of Israel issued the following statement:
The Monetary Committee decides on August 29, 2017 to keep the interest rate unchanged at 0.1 percent
“· The inflation environment remains markedly lower than the target, but it does not reflect a decrease in demand. In the past two months, there was a sharp decline in inflation, but inflation expectations for the various ranges did not change markedly. The increase in wages in the economy and the change in the trend of the exchange rate, to the extent that it persists, will support inflation, while the effect of additional initiated price reductions and the moderation of inflation worldwide act to reduce the inflation rate.
· The rate of growth in the first half of 2017 (net of the impact of vehicle imports) is somewhat moderate compared with the accelerated growth in 2016, against the background of the labor market being at full employment. Exports are growing at a solid pace as a result of the rapid expansion of services exports, while growth of goods exports remains slow.
· The picture of global economic activity is improving, and world trade is growing by a solid rate. In Europe, growth is becoming entrenched and political risk has decreased, but in the US, the difficulties encountered by the administration in implementing its economic policy are weighing on growth. Inflation is lower than central banks’ targets, and changes in Federal Reserve and ECB policies are not expected in the near future.
· In recent months, the shekel appreciation has halted: Since the last monetary policy discussion there was a depreciation of 3.2 percent in terms of the nominal effective exchange rate; the shekel weakened primarily against the euro and to a moderate extent against the dollar. Over the past 12 months, the appreciation in terms of the effective exchange rate was 4.1 percent.
· From the beginning of the year, home prices have risen by a moderate rate and most indicators point to stabilization of activity in the housing market.
The Monetary Committee intends to maintain the accommodative policy as long as necessary in order to entrench the inflation environment within the target range. The Bank of Israel continues to monitor developments in inflation, the real economy, the financial markets, and the global economy, and will act to attain the monetary policy targets in accordance with such developments.
Since the previous interest rate decision, there has been a sharp decline in inflation: The rate of inflation over the past 12 months declined to -0.7 percent (Figure 1 in the data file). Even net of initiated price reductions, the inflation rate is negative (Figure 2). The decline in the inflation rate does not reflect a decrease in demand; apparently, the CPI was temporarily impacted by technical changes in the method of measuring the clothing and footwear component. Furthermore, the cumulative appreciation in the exchange rate to the beginning of July (Figure 6) had a sharp impact on prices of tradable goods (Figure 3). In addition, the enhancement of competition in the economy is apparently preventing price increases in some industries. The wage increases in the economy and the change in the trend of the exchange rate, to the extent that it persists, will support inflation, while the effect of additional initiated price reductions and the moderation of inflation worldwide act to reduce inflation. The decline in inflation was accompanied by a decline in 1-year inflation expectations derived from the capital market, but forecaster’s projections, as well as medium-term and long-term forward expectations, remained stable. Forward expectations beginning from the end of the third year are anchored within the target range (Figure 5).
Since the previous interest rate decision, there has been a sharp decline in long-term government bond yields and the spread vis-à-vis US government bond yields is at a historic low. Yield spreads between corporate and government bonds are also at a low level (Figure 7).
The initial estimate of National Accounts data for the second quarter indicates that the rate of growth in the first half of 2017 (net of the effect of vehicle imports) is somewhat moderate compared with the accelerated growth in 2016. Against the background of the acceleration in the growth rate of world trade, exports are growing at a solid pace as a result of the rapid expansion of services exports (Figure 12). Growth of goods exports remains low, against the background of the cumulative appreciation through the beginning of July. The most recent data indicate continued growth of economic activity at a similar rate in the beginning of the third quarter. The moderation in growth reflects supply side constraints derived from the labor market being at full employment—the job vacancy rate continues to increase; participation and employment rates are stable at high levels, and unemployment is low. The wage increase in the business sector halted in recent months (Figure 14), but the overall wage increased by 3.9 percent in the past year, and the growth in health tax receipts indicates that apparently wage increases are continuing.
Housing market data continue to indicate moderate demand and a slowing of activity. From the beginning of the year, home prices increased by a moderate rate (Figure 8), the number of transactions remains moderate relative to 2016, and home purchases by investors continue to decline. The monthly pace of new mortgages granted increased slightly in the past two months, and a downward trend in the interest rate is apparent in recent months (Figure 9).
The improvement in global economic activity continues, and world trade is growing at a solid pace (Figure 17). The IMF kept its global growth forecast unchanged, while reducing the forecast for US growth and increasing the forecast for other major blocs (Figure 16). Inflation in most major economies remains below target (Figure 19), and major central banks did not change their accommodative policies. US growth recovered in the second quarter, driven by private consumption, but the difficulties encountered by the administration in implementing its economic policy are weighing on future growth. Despite the improvement in the labor market, the low inflation rate led to a decline in the Fed’s expected interest rate path, and it is not clear when it will begin the process of reducing its balance sheet. In Europe, growth is becoming entrenched, encompassing most economies in the bloc in the second quarter, and sentiment indices indicate continued improvement in the coming months. The low inflation rate is expected to delay the ECB’s stepping back from its quantitative easing. Uncertainty regarding the Brexit process continues to weigh on growth in the UK. In Japan, there was especially high growth in the second quarter. In China, growth remained stable, but activity data indicate a slight moderation in the beginning of the third quarter. Oil prices increased slightly, with fluctuations in supply.”
