The Bank of Israel (BOI), which has kept its rate steady since cutting it in March 2015, also reiterated that is considers that the risks of reaching its inflation target of 1 percent to 3 percent "remain high," but added that "increases in wages and in global inflation are expected to support the return of inflation to the target."
The reference to higher wages and global inflation is new compared with last month's statement.
Israel's consumer price inflation rate eased to minus 0.2 percent in December from 0.3 percent in November. Israel has experienced deflation since September 2014.
But the BOI added inflation was "on an upward trend," with the impact of administrative price cuts dissipating while energy prices were steady on an annual basis.
Short-term inflation expectation still remain below the central bank's target while longer-term expectations remain anchored near the target's midpoint and financial markets pricing in a high probability of an interest rate increase to 0.25 percent in about a year, the BOI said.
"The picture of real economic activity remains positive," the central bank said, adding that data indicated a recovery of manufacturing exports after a prolonged decline since 2015.
Israel's economy grew by an annual rate of 3.8 percent in the third quarter of last year, up from 3.6 percent in the second quarter.
After falling sharply in the second half of 2014, Israel's shekel has been slowly firming and has appreciated by 6.2 percent over the past 12 months in terms of nominal effective exchange rate.
"The level of the effective exchange rate continues to weigh on the development of goods exports," the BOI said.
The Bank of Israel issued the following statement with its main considerations behind its policy decision:
"The decision to keep the interest rate for February 2017 unchanged at 0.1 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 range of 1–3 percent a year, and to support growth while maintaining financial stability. The Monetary Committee continues to assess that in view of the inflation environment, and of developments in the global economy, in the exchange rate, as well as in monetary policies of major central banks, monetary policy will remain accommodative for a considerable time.
Following are the main considerations underlying the decision:
· The CPI for December was unchanged, in line with expectations. The inflation rate was negative in 2016, but is on an upward trend. The direct effect of administrative price reductions is dissipating, and energy prices remained unchanged, as measured over the preceding 12 months. The low rate of inflation reflects the effect of the appreciation, and possibly structural change and enhanced competition in the economy. Short-term inflation expectations are below the target, while longer term expectations derived from the capital market remain anchored near the midpoint of the target range.
The picture of real economic activity remains positive. The Composite State of the Economy Index increased by 0.45 percent in December, and the Net Balance in the fourth quarter Companies Survey indicates high growth of business sector product. Foreign trade data indicate a recovery of manufacturing exports, after a prolonged decline since 2014. The picture conveyed by the labor market remains very positive, and the increase in employment and wages was led by the business sector in the past year.
· The global economy continues to grow at a moderate pace. The IMF revised its growth forecast for advanced economies and for China upward, and expects a recovery in world trade in the next two years. With that, political developments in some advanced economies are likely to weigh further on trade growth. In the US, the improvement in activity continued, inflation is nearing the target and market assessments are that the federal funds rate will be increased twice in 2017. Nonetheless, there is uncertainty regarding the expected economic policy. In Europe, the recovery is less entrenched, and accommodative monetary policy continues, with political uncertainty remaining high.
· From the monetary policy discussion on December 25, 2016, through January 20, 2017, the shekel strengthened by 0.2 percent against the dollar, while it depreciated by 0.3 percent in terms of the nominal effective exchange rate. The shekel has appreciated by 6.2 percent over the past 12 months in terms of the nominal effective exchange rate, against the background of a 6.7 percent appreciation vis-à-vis the euro. The level of the effective exchange rate continues to weigh on the development of goods exports.
· Home prices continue to rise rapidly, despite a high level of unsold new homes, a decline in monthly mortgage volume, and a continued increase in mortgage interest rates.
The Monetary Committee is of the opinion that the risks to achieving the inflation target remain high, yet the increases in wages and in global inflation are expected to support the return of inflation to the target. 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 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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