David Klein, the Governor of the Bank of Israel, announced on
Monday that the Bank of Israel's key interest rate for June
would be 8.0 percent, 0.4 percent below the current rate. The
interest rate reduction is at the higher end of the what was
predicted.
Rates were expected to fall since inflation expectations are
now under 2 percent for the coming twelve months. Also the
increases in money supply have been low, the shekel is very
strong on foreign exchange markets, and there is the
expectation that the government's economic emergency plan
will soon be approved by the Knesset.
This was the third rate reduction this year. The prime rate
will be at 9.5 percent, and the Bank of Israel rate will be 8
percent. These figures are still much higher than almost
anywhere else in the world. The rate has fallen one percent
so far this year in two steps of 0.3 percent and the current
step of 0.4 percent.
At the beginning of March expectations were for inflation of
over 4 percent in the next 12 months, but today they are at
1.2 percent. The main cause of this change in expectations is
the shekel's rise to its highest value since January 2002,
being fixed at 4.454 shekels to the dollar last Friday. Today
the shekel has continued to climb another 0.2 percent to
4.446. Conversely the main cause of last year's inflation was
the sudden sharp rise in the dollar.
This year from a CPI of 0.4 percent in February, the
direction has been down with a negative index of -0.2 percent
in April. Expectations are that the price levels will
continue to fall.
The Bank of Israel wants to keep a sharp differential between
the interest rates in Israel and those elsewhere. But now,
the U.S., Britain and the Euro bloc have all indicated the
possibility of further reductions. Lower foreign interest
rates would allow further reductions here while maintaining
the gap in rates between currencies. The present interest gap
between the dollar and the shekel of 6.75 percent is a major
source of strength for the shekel.
Excerpts from the Bank of Israel's announcement:
"In the last few months, the decline in one-year inflation
expectations derived from the capital market persisted, and
they are close to the lower limit of the government's price-
stability target (1-3 percent). Inflation expectations for
the second year ahead and beyond have also declined, and for
most years are now within the target range. Private
forecasters' predictions of 12-month inflation are within the
range of 1-2 percent, and the models developed by the Bank of
Israel indicate that it is possible to attain the inflation
target for the coming year and the following year while
continuing to reduce the interest rate. The reduction in risk
was reflected in the strengthening of the NIS in the last few
months and in the continued reduction of the interest rates
on unindexed long-term government bonds to about 8.5 percent,
down from its peak of about 11.7 percent in February 2003. .
. . there is still considerable uncertainty regarding the
effects of the implementation of the government's economic
program and there is concern that despite the budget cuts,
the deficit this year and in the next few years will be
higher than the path set by the government. If this does
occur, long-term interest will be unable to achieve its full
potential reduction, which is necessary to encourage
investment and growth in the economy.
" . . . the [new] program does not ensure convergence to a
downward path for the deficit and for the debt/GDP ratio, and
at this stage is inconsistent with the government decision to
adhere to the downward path of the deficit from 3 percent of
GDP in 2003 to one percent in 2007. . . . Fiscal discipline
is an essential requisite to attract sources from private
savings into investment and credit, for the continued
reduction of long-term interest on government bonds, and
hence for the reduction of interest on credit for investment
and mortgages that is so important for renewed growth and the
encouragement of employment. Structural reforms passed by the
government, the implementation of which can boost economic
growth, are of great importance. In this context, the
pensions reform that diverts the pension funds into the
capital market with the intention of encouraging investment
and growth will be unable to attain its objective without a
reduction in the government deficit, which will enable
sources of finance to be allocated to private-sector
investments. . . .
"The Bank of Israel keeps a watchful eye on exchange-rate
developments, and in particular analyses their implications
for the inflation rate, but it is a long time since the
exchange rate at any level, its trend, or its volatility have
in themselves constituted targets for monetary policy.
Furthermore, the high level of functioning of the foreign-
currency market currently encourages the development of
financial instruments that provide protection against
exchange-rate risk, thus offering companies and individuals
improved protection against the risks inherent in the natural
volatility of the market. . . .
" . . . the Bank will act to support the government's policy
to foster employment and shorten the recession."
