BANK OF ISRAEL
Office of the Spokesperson and Economic Information
December 29, 2014
Press Release
Research Department Staff Forecast, December 2014
Abstract
This document presents the forecast of macroeconomic developments compiled by the
Bank of Israel Research Department in December 2014. The forecast was presented to
the Monetary Committee on December 28, 2014, during its meeting prior to the
decision on the Bank of Israel interest rate for January 2015. According to the staff
forecast, gross domestic product (GDP) is projected to increase by 2.5 percent in
2014, and by 3.2 percent in 2015, and 3.0 percent in 2016. The rate of inflation over
the next year (ending in the fourth quarter of 2015) is expected to be 1.1 percent. The
Bank of Israel interest rate is expected to be 0.25 percent during 2015.
Forecast
The Bank of Israel Research Department compiles a staff forecast of macroeconomic
developments on a quarterly basis. The staff forecast is based on several models,
various data sources, and assessments based on economists' judgment. 1 The Bank's
medium scale DSGE (Dynamic Stochastic General Equilibrium) model developed in
the Research Department—a structural model based on microeconomic foundations—
plays a primary role in formulating the macroeconomic forecast.2 The model provides
a framework for analyzing the forces which have an effect on the economy, and
allows the integration of information from various sources into a macroeconomic
forecast for real and nominal variables, with an internally consistent "economic
story".
a. The global environment
Since the publication of the previous staff forecast in September, oil prices have fallen
very sharply. The price of Brent crude oil has fallen by about 40 percent, from $102
per barrel at the beginning of September to about $60 per barrel in mid-December.
Global oil prices have fallen due to assessments that the supply of oil is high
compared to expected demand, in view of new oil production technologies, mainly in
the US, and the announcement by OPEC that despite the sharp decline in oil prices, it
does not intend to reduce the quantity of oil produced by its member countries.
1
An explanation of the staff macroeconomic forecast, and an overview of the models on which it is
based, can be found in Inflation Report 31 for the second quarter of 2010, section 3-C.
A Discussion Paper on the model is available on the Bank of Israel website, under the title: “MOISE:
A DSGE Model for the Israeli Economy,” Discussion Paper No. 2012.06.
2
Bank of Israel - Research Department Staff Forecast, December 2014
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Global inflation projections by foreign investment houses declined, affected inter alia
by the sharp decline in oil prices.
The current assessments of expected developments in the global environment are
based mainly on projections by international institutions (the International Monetary
Fund and the OECD) and of foreign investment houses. The projections reflect
assessments that the pace of growth in GDP in the advanced economies will improve
in 2015 and 2016, although at a moderate pace, and with variance between countries.
In particular, relative weakness is expected in Europe and Japan, while stronger
growth is expected in the US. Growth projections for Europe and Japan are lower than
our assessments when compiling the previous forecast (in September).
The pace of growth in global trade is expected to accelerate in 2015, alongside the
improvement in growth. However, compared to the assessments in September, the
recent assessments are that the improvement will be more moderate. For instance, the
recent projection published by the OECD (at the end of November) was that the rate
of growth in imports to the OECD in 2015 would be 3.7 percent, compared to 5.5
percent in the OECD’s projection published in May.3 Further improvement in global
trade is expected in 2016.
b. Real activity in Israel
GDP growth is expected to be 2.5 percent in 2014. This projection is slightly higher
than the estimate in the previous forecast (at the end of September), which was 2.3
percent. A main contributing factor to this is the upward revision of GDP growth data
in the first half of the year as published by the Central Bureau of Statistics. We
estimate that Operation “Protective Edge” in the third quarter of the year detracted
about 0.3 percent from annual GDP, mainly due to a negative impact on the export of
tourism services and on private consumption. In contrast, growth in the purchases of
durable goods, particularly automobiles, contributed to growth in private consumption
in 2014. Based on the Research Department’s assessment, the recovery of activity
from its relatively low level in the third quarter of 2014, due to Operation Protective
Edge, will be expressed in a relatively high growth rate over the coming quarters
(beginning with the fourth quarter of 2014).
GDP in 2015 is expected to grow by 3.2 percent. Fixed capital formation and
exports are expected to contribute to improvement in the pace of growth in 2015. An
increase in the growth rate of exports is expected due to improvement in global trade,
the depreciation of the shekel that has taken place in the second half of 2014, and the
recovery of tourism services that were negatively impacted in 2014 due to Operation
Protective Edge. Fixed capital formation is expected to recover in 2015, following a
decline in 2014 in both investment in the major industries and in investment in
construction. The sharp decline of oil prices is expected to support private
consumption, but in contrast, we expect some decline from the high level of purchases
3
In the previous staff forecast published in September, it was assumed that the rate of growth in OECD
imports would be 5 percent.
Bank of Israel - Research Department Staff Forecast, December 2014
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of durable goods in 2014. Further improvement in global trade is expected in 2016,
which will support improvement in Israeli exports.
In view of the failure to approve the State budget for 2015 and the announcement of
general elections to take place in March 2015, there is a relatively high level of
uncertainty regarding fiscal policy. Our assumptions regarding public consumption in
the current staff forecast are based on the budget proposal that was approved in first
reading in the Knesset. With that, the late approval of the budget for 2015 may lead
to government expenses being lower than those included in the most recent budget
proposal. In such a scenario, growth in 2015 is expected to be slightly lower, but
growth in 2016 is expected to be higher, since the fiscal cuts required in 2016 to meet
the expenditure ceiling as per the expenditure rule will be more moderate.
Table 1: Economic Indicators
Research Department Staff Forecast for 2014 to 2016
(rates of change, percent, unless stated otherwise)
Bank
Bank
Bank
of
of
of
Israel
Israel
Israel
forecast forecast forecast
for
for
for
1024
1025
1026
GDP
2.5
3.2
3.0
Civilian imports (excluding diamonds, ships, and aircraft)
3.0
4.4
6.0
Private consumption
3.3
3.2
3.3
Fixed capital formation
-1.1
2.6
6.9
Public sector consumption (excluding defense imports)
3.3
4.1
0.0
3.9
Exports (excluding diamonds and start-ups)
4.6
5.4
a
Unemployment rate
6.0
5.7
5.7
b
Inflation rate
-0.2
1.1
2.0
Bank of Israel interest ratec
0.25
0.25
1.00
a) Annual average.
b) Average CPI reading in the final quarter of the year compared with the final quarter average in the
previous year.
c) Year-end.
Source: Bank of Israel.
c. Inflation and interest rate estimates
In our assessment, the rate of inflation during the four quarters ending in the
fourth quarter of 2015 will be 1.1 percent.
The relatively low inflation rate expected in 2015 (near the lower bound of the
inflation target) includes the effect of electricity and water price reductions in
January, among other things. Excluding the direct effect of these reductions on the
Consumer Price Index, the inflation forecast for 2015 is 1.5 percent. This rate is
higher than the forecast of inflation over the four quarters ending in the fourth quarter
of 2015 as it was in September (1 percent).
Bank of Israel - Research Department Staff Forecast, December 2014
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The main factor acting to increase inflation in 2015 is the significant depreciation of
the shekel that took place in the second half of 2014. The nominal effective exchange
rate of the shekel was about 6 percent lower in December than its level in the first half
of 2014. Against the dollar, the shekel was about 13 percent lower in December than
it was in the first half of the year. Our assessment is that the effect of the depreciation
will be reflected in inflation in 2015. In contrast, a main development moderating
inflation in 2015 is the sharp decline in oil prices in the last quarter of the year: the
price of Brent crude declined by about 40 percent, from about $100 a barrel in
September to about $60 a barrel in December.4 The decline in the price of oil is also
reflected a decline in projections of expected global inflation in 2015.
In the Research Department’s assessment, the Bank of Israel interest rate is
expected to be 0.25 percent during 2015, and to begin increasing in 2016. Our
assessment is that the Monetary Committee will leave the interest rate at its low level
in the coming quarters in order to support economic activity and a return of inflation
to around the midpoint of the target range. In view of the improvement in the US
economy, the interest rate there is expected to begin increasing moderately in the
second half of 2015, but expectations derived from the capital market relating to the
expected increase in the interest rate there moderated in the last quarter, apparently in
view of the moderating effect of the sharp decline of oil prices on inflation. In other
countries, such as the eurozone and Japan, the interest rate is not expected to increase
before 2016. As Figure 2 shows, the expected path of interest rates in 2015 is similar
to the path in the forecast published in September.
Table 2 shows that the Research Department’s inflation projection for the next
year is higher than the average assessment of professional forecasters and higher
than expectations derived from the capital market. As to the interest rate, the
Research Department’s forecast is slightly lower than the average projection of the
forecasters, which projects an increase in the interest rate to 0.5 percent by the end of
2015.
According to the Research Department’s DSGE model, the decline in the price of crude oil by about
40 percent is expected to reduce annual inflation by about 1 percentage point.
4
Bank of Israel - Research Department Staff Forecast, December 2014
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Table 2
Forecasts for inflation rate and interest rate for the coming year
(percent)
Bank of Israel
Research
Capital
Department
marketsa
Private forecastersb
Inflation ratec
1.1
0.6
0.6
(range of forecasts)
d
Interest rate
0.25
(range of forecasts)
0.32
((-0.1)–1.1)
0.47
(0.1–1.0)
a) Average for the month of December (through December 24). Inflation expectations are seasonally
adjusted.
b) Inflation and interest rate forecasts are after the publication of the CPI reading for November.
c) Inflation rate over the next 12 months (Research Department: in the next four quarters).
d) The interest rate one year from now. Capital markets forecast derived from Telbor rates.
Source: Bank of Israel.
d. Balance of risks in the forecast
Domestic and global factors may lead to developments in the domestic economy that
are different than those in the baseline forecast. In the assessment of foreign entities5,
the risks to global growth are tending downward, particularly in Europe. In contrast,
it is possible that the sharp drop in oil prices may have a stronger effect on activity in
oil importing economies than previously assessed, and that global growth rates—and,
accordingly, trade volume—may be higher. As to prices, the drastic decline of oil
prices is moderating inflation, and in countries where inflation is low, the concern of
deflation is increasing, particularly in view of the near-zero level of short-term
interest rates. Another risk factor has to do with the exchange rate of the shekel. As
previously noted, the depreciation of the shekel that took place in the second half of
2014 is a main factor that is expected to increase inflation in the next year—on the
assumption that the relatively low level of the shekel is maintained. We also note the
uncertainty in relation to government policy in view of the fact that the government
budget for 2015 has not been approved, and in view of the Knesset elections planned
for March 2015.
Figures 1 and 2 present fan charts around the inflation rate and interest rate forecasts
(the broken line represents the baseline forecast of September 2014). The width of the
fan is derived from the estimated distributions of the shocks in the Research
Department's DSGE model.
5
See, for instance, the OECD Economic Outlook published at the end of November.
Bank of Israel - Research Department Staff Forecast, December 2014
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Figure 1
Actual Inflation and Fan Chart of Expected Inflation
(cumulative increase in prices in previous four quarters)
The center of the fan chart is based on the Bank of Israel Research Department assessment. The width
of the fan is based on the Department’s medium-scale DSGE (dynamic stochastic general equilibrium)
model. The full fan covers 66 percent of the distribution of expected inflation.
The dotted line corresponds to the previous staff forecast (published in September 2014).
Source: Bank of Israel.
Figure 2
Actual Bank of Israel Interest Rate and Fan Chart of Expected Interest Rate
The center of the fan chart is based on the Bank of Israel Research Department assessment. The width
of the fan is based on the Department’s medium-scale DSGE (dynamic stochastic general equilibrium)
model. The full fan covers 66 percent of the distribution of expected interest rate.
The dotted line corresponds to the previous staff forecast (published in September 2014).
Source: Bank of Israel.
Bank of Israel - Research Department Staff Forecast, December 2014
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