The Bank of Israel (BOI), which has cut its rate by a total of 75 basis points this year, also said inflation had continued to decline with expectations for the coming year dropping below the lower bound of its 1 - 3 percent target range. Longer-term inflation expectations have also declined but are near to the midpoint of the bank's range.
Israel's headline inflation rate dropped to minus 0.3 percent in September from zero in August.
The BOI also noted the continuing weakening of the shekel's exchange rate, with its effective exchange rate down by 2.8 percent in the last month for a cumulative drop of 4.1 percent this year.
"Continued depreciation will support a recovery in exports and in the tradeable sector as a whole, and is expected to contribute to returning the inflation rate to within the target range," BOI said.
Since Aug. 4 the shekel has been depreciating, trading at 3.79 to the U.S. dollar today, down some 9 percent from 3.47 at the start of the year.
Economic activity in the third quarter slowed, according to recent indicators, and might even have declined, the BOI said, adding that most of the economic slowdown was due to Operation Protective Edge. On July 8 Israel launched a military operation in Gaza that has led to the death of over 2,000 people, mostly Palestinians, and since then its economy has slowed sharply.
In the second quarter, Israel's Gross Domestic Product expanded by only 0.36 percent from the first quarter for annual growth of 2.24 percent, down from a rate of 3.21 percent in the first quarter.The BOI also noted the continuing weakening of the shekel's exchange rate, with its effective exchange rate down by 2.8 percent in the last month for a cumulative drop of 4.1 percent this year.
"Continued depreciation will support a recovery in exports and in the tradeable sector as a whole, and is expected to contribute to returning the inflation rate to within the target range," BOI said.
Since Aug. 4 the shekel has been depreciating, trading at 3.79 to the U.S. dollar today, down some 9 percent from 3.47 at the start of the year.
The BOI issued the following statement with the main considerations behind its decision:
"The decision to keep the interest rate for November 2014 unchanged at 0.25 percent is consistent with the Bank of Israel's monetary policy, which is intended to return the inflation rate to within the price stability target of 1–3 percent a year over the next twelve months, and to support growth while maintaining financial stability. The path of the interest rate in the future depends on developments in the inflation environment, growth in Israel and in the global economy, the monetary policies of major central banks, and developments in the exchange rate of the shekel.
The following are the main considerations underlying the decision:
- The inflation environment continued to decline this month. The inflation rate measured over the preceding 12 months was negative 0.3 percent. Inflation expectations for the coming year, from various sources, declined to below the lower bound of the inflation target range, and two-year expectations are at the lower bound. Expectations for longer terms declined as well, though they are near to the midpoint of the target range.
- Most indicators that became available this month signal that activity in the third quarter slowed, and perhaps even declined. Most of the slowdown in activity derives from Operation Protective Edge. The Companies Survey points to a decline in activity in the third quarter in all industries, primarily in tourism. There was no substantial decline in confidence indices despite Operation Protective Edge, and there was improvement in the Purchasing Managers Index.
- In light of the reductions in the Bank of Israel interest rate, and the strengthening of the dollar worldwide, the shekel weakened by 2.8 percent this month in terms of the nominal effective exchange rate, and it has weakened by about 4.1 percent since the beginning of the year. Continued depreciation will support a recovery in exports and in the tradable sector as a whole, and is expected to contribute to returning the inflation rate to within the target range.
- Concern increased this month of a further moderation in the global economy, against the background of the increased uncertainty and volatility in various markets. Disappointing data were received this month in the eurozone, with an emphasis on its larger economies. In the US, the recovery in growth continues, though there are downside risks to the forecast. Based on market assessments, the timing of when the Fed will begin to raise the federal funds rate has been deferred to around October 2015.
- The sharp decline in the number of transactions in the housing market continues, and there is a moderation in the rate of mortgages being taken out. Home prices declined by 1 percent in July-August, and their rate of increase over the 12 months ending in August slowed to 5 percent. It is difficult to assess the response that will occur when the uncertainty regarding the zero-VAT law is removed.
- Net new investment in corporate bond funds continues, though at relatively low volumes. Spreads in this market continue to indicate an apparent underpricing of risks.
The Monetary Committee is of the opinion that the effects of the recent interest rate reductions, which brought the interest rate to a level of 0.25 percent, have not yet been fully reflected in activity and in inflation, and in light of that decided to keep the interest rate unchanged this month.
The Bank of Israel will continue to monitor developments in the Israeli and global economies and in financial markets. The Bank will use the tools available to it and will examine the need to use various tools to achieve its objectives of price stability, the encouragement of employment and growth, and support for the stability of the financial system, and in this regard will continue to keep a close watch on developments in the asset markets, including the housing market."
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