Yesterday and today, the Monetary Committee held discussions at the Bank of Israel to make its policy decision. Since our previous interest rate decision, at the end of November, the state and the economy have been experiencing a number of conflicting processes. On the health front, the vaccination campaign we have been waiting for has started sooner than expected, and so far, the immunization rate is high by any standard. On the other hand, the morbidity is increasing, there is a growing fear of the possibility of a mutation spreading that increases the rate of infection, and the government has decided on a third closure in order to reduce the extent of the morbidity.
On the political front, the Knesset has dispersed without approving a budget for 2021 and the state is marching towards a fourth election in the last two years, for all that that implies. The Monetary Committee tried to assess the overall impact of all these processes on economic activity and inflation, and ultimately decided to leave the interest rate at 0.1%, while the Bank of Israel continues to operate a wide range of policy instruments as it did throughout the crisis.
Before detailing the situation presented to the Committee and the considerations that led to the decision, I will take this opportunity to briefly summarize the events of the past year from the perspectives of monetary policy makers.
There is no superlative that has not been used to describe the past year. It was exceptional in many ways, and even in the world of central banks the year 2020 set quite a few records. If in January we were still dealing theoretically with the possible consequences of a virus spreading in China, then in February and March the rapid pace of developments obliges us to take determined policy measures, on a large scale, and at record speed.
The collapse of the financial markets with the imposition of restrictions on movement and activity in many economies created an acute liquidity crisis in the global markets, which was reflected in Israel mainly in the bond market and the foreign exchange market.
In parallel with the actions of the world’s leading central banks, the Bank of Israel acted quickly to provide liquidity to the economy in shekels and foreign exchange, and stabilized the markets within a few days. We then took a variety of steps to ensure that the credit market supports the needs of all types of borrowers. We also did this through well-known policy tools in Israel and around the world – reducing interest rates, purchasing government bonds and later also corporate bonds, and also using tools we developed according to the dimensions of the Israeli economy.
We identified early on the increased difficulty among small businesses, and launched a number of programs to make sure that credit continues to flow in the direction of these businesses as well. At the same time, as we reap the rewards of maintaining the strength and stability of the banking system over the years, we have taken a wide range of steps within the powers of the Supervisor of Banks to ensure the ability of banks to continue to provide credit to the economy.
And similar to what has been done in other countries, we have also led a voluntary outline of deferring credit payments amounting to billions of shekels for households and small businesses affected by the crisis, which provided them with a quick response to the cash flow difficulty created.
The health crisis has led to an unprecedented economic crisis, requiring a determined response from government policy. Here, too, the fiscal credibility that the Israeli economy gained in the years leading up to the crisis was to our credit. The political situation undoubtedly made it difficult, and despite this the government provided extensive assistance to the unemployed, to the affected businesses, to providing a response to the health system, and more. The Bank of Israel continues to be involved in analyzing the economic challenge and in ongoing consultation with government ministries regarding the formulation of policy measures.
The lack of an orderly state budget for 2021 and the need to rely on a continuation budget based on it as early as 2018, make it very difficult for the government to activate growth accelerators and take steps to prepare the economy for the post-crisis period. At the same time it is important to find ways to effectively use the budget earmarked for growth accelerators, such as infrastructure, digitization and technology, which is included in the 2021 Corona box.
Economic developments throughout the year have again illustrated the resilience of the Israeli economy. The restrictions and closures led to a drop in economic activity, but whenever supply restrictions were lifted, we saw economic activity skyrocket. Some businesses were able to adapt the nature of their activities to the new situation, and the high-tech services sector stood out, as reflected in the continued growth of services exports, with the exception of of course tourism services.
In the second closure we have already seen that the harm to activity was less severe than in the first closure. However, the situation in the labor market, even before entering the current closure, is far from encouraging. Unemployment has not been able to fall to a single-digit rate again, and various indices show that most of the damage is suffered by the weak workers in industries that are already characterized by low productivity and wages. Among businesses, too, the injury is concentrated mainly in small businesses, especially in industries whose characteristics do not allow them to operate under health restrictions.
According to estimates, in 2020 there was a (net) decrease in the number of businesses in the economy, for the first time in many years. We currently do not yet have data on the impact of the third closure on the labor market and business activity, and there is also uncertainty about the length of time it will be necessary to continue to maintain the restrictions.
The Bank of Israel’s Research Division today published an updated forecast in which it estimates that the contraction in GDP in 2020 will be about 3.7%. The uncertainty also affects forecasts for the coming years, and the division continues to publish a forecast based on two scenarios. In the “rapid vaccination” scenario, the division assumes that by the end of the second quarter of 2021 the health situation will no longer impose significant restrictions on economic activity. In this scenario, the economy is expected to grow at a rate of 6.3% in 2021 and 5.8% in 2022.
Even then, GDP in 2022 is expected to be about 2% lower than it would have been had it not been for the crisis, and the broad unemployment rate at the end of the year is expected to be 5.4%. In a more pessimistic scenario, in which the vaccination campaign will be extended so that the restrictions on economic activity will continue until mid-2022, only 3.5% growth is expected in 2021 and 6% in 2022, so that GDP in 2022 will be 4.5% lower than expected without the crisis , And the broad unemployment rate will stand at 7%.
In the first scenario, the rise in inflation is expected to be faster than in the second scenario, but in both scenarios inflation is lower than the target. In order to support the economic recovery and the return of inflation to the target, the estimate is that the Bank of Israel interest rate will be at 0-0.1%, and that the Bank of Israel will be able to continue to deepen the degree of monetary expansion as necessary.
Throughout the crisis we have been faithfully monitoring the developments in the credit market and its various derivatives. The data show, first and foremost, that credit in the economy continues to flow without an increase in interest rates, despite the significant increase in risk for some borrowers. State-guaranteed credit funds are an important source of credit for many businesses, and the outline of deferring lending by the banking system, and later also by credit card companies, has allowed many households and businesses to reorganize their payment schedule and avoid insolvency in light of the crisis.
A few weeks ago, a new outline was formulated that emphasized the need to start renewing credit repayment, even if in part, so that the debt would be sustainable for both lenders and borrowers. We recently announced that in light of the exceptional circumstances of the crisis, the Bank of Israel will also allow lenders outside the banking system to receive credit on favorable terms, as long as this credit is used to provide cheap credit to small and small businesses.
In addition, I announce today that after creating the legal and operational infrastructure, we began to implement the decision a few days ago that allows banks to also put mortgage portfolios as collateral against loans they receive from the Bank of Israel for credit to small and small businesses. This instrument, which has hitherto existed mainly in the central banks of the US, Europe and the UK, increases the incentive for banks to provide credit to businesses without eroding liquidity ratios, and can be used to inject credit into the economy quickly in the future as needed.
At the same time, the Bank of Israel continues to support low levels of medium- and long-term interest rates and the ability to raise larger businesses in the capital market, through the plans to purchase government bonds and corporate bonds that we announced in previous months.
Inflation in Israel was low even before the crisis broke out, and the sharp decline in demand led to a further gradual decline in inflation, in Israel and around the world.
In the end data of inflation, a moderate increase is beginning to be seen, and if the recovery from the crisis takes place as expected, inflation is also expected to continue to rise. We estimate that within a few months annual inflation will return to the positive range, and once the effect of the appreciation accumulated in the exchange rate expires – which I will expand on later – it will continue to rise gradually towards the lower limit of the target. It is important to note that throughout the crisis, medium- and long-term expectations remained anchored within the inflation target range.
Significant uncertainty continues to accompany the global economy as well. A significant increase in morbidity that preceded vaccination campaigns leads to the return of restrictions and closures in many countries, and especially in the main economies. However, it seems that in the world as well, some of the companies are succeeding in adapting to the new conditions – the industrial sector continues to recover, and with it global trade, which is so essential to a small and open economy like Israel. The political uncertainty in the world diminished with the completion of the Brexit process and the clarification of the political picture in the United States.
Major central banks continue to pursue very broad policies, while maintaining zero interest rates in the US and negative in Europe and Japan, and large-scale asset purchase and lending programs. The broad monetary policy is expected to continue for at least a few more years.
After relative stability in the summer months, the shekel began to strengthen in early October, and this trend accelerated in November and December. Part of the appreciation is the result of global developments – the dollar weakened against most currencies – and also against the shekel – but the appreciation of the shekel against the dollar is noticeable relative to other currencies.
The analysis conducted at the Bank of Israel shows that some of the appreciation can be attributed to good reasons: the Israeli economy enjoys a growing surplus in the current account. Leading technology companies continue to invest in the Israeli economy, and large investment bodies around the world have increased their holdings in Israeli government bonds, also in light of Israel’s inclusion in the WGBI index.
The performance of exports of services throughout the crisis stands out favorably, and recently there has also been a recovery in exports of goods. However, it is difficult to assess the point at which the exchange rate may be too strong for some of the export and import substitutes industry, and this is not a risk we would like to take in a crisis.
Therefore, the Bank of Israel operated the foreign exchange market intensively during the year, purchasing a record amount of about $ 20 billion. This policy moderated the appreciation rate, to ensure that the exchange rate does not strengthen significantly beyond what matches the dynamic window derived from the underlying forces. That this policy will continue in accordance with the need of the same assessment by the Monetary Committee, and that in the current circumstances the level of foreign exchange reserves does not constitute a limitation on the foreign exchange purchases policy.
As I mentioned at the beginning of my speech, today the Monetary Committee decided to leave the interest rate unchanged. At the same time, the Bank of Israel continues to operate the entire arsenal of monetary tools we operated throughout the crisis – purchases of government and corporate bonds, special loan programs to increase the supply of credit to small businesses, and intervention as needed in the foreign exchange market.
In doing so, the expansionary monetary policy will continue to accompany the exit of the Israeli economy from the economic crisis, as we all hope that the light at the end of the health crisis tunnel will intensify, so that 2021 will indeed be a year of recovery and growth, in every sense.
I wish us all a successful civic year! Thank you.
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