Leumi Economic Weekly November 23, 2016 Relatively rapid growth also in the third quarter of the year; our 2016 growth forecast is expected to be revised upwards The initial estimate on third quarter 2016 economic activity in Israel shows GDP increased 3.2% compared to the preceding quarter (in annualized terms, seasonally adjusted data). The business sector product, which does not include the contribution of government expenditures to GDP, nor other relatively small components of activity, increased by an annualized rate of 3.6%.

%

Gross Domestic Product Quarterly rate of change, annualized, %, constant prices

Q1-2007 Q2-2007 Q3-2007 Q4-2007 Q1-2008 Q2-2008 Q3-2008 Q4-2008 Q1-2009 Q2-2009 Q3-2009 Q4-2009 Q1-2010 Q2-2010 Q3-2010 Q4-2010 Q1-2011 Q2-2011 Q3-2011 Q4-2011 Q1-2012 Q2-2012 Q3-2012 Q4-2012 Q1-2013 Q2-2013 Q3-2013 Q4-2013 Q1-2014 Q2-2014 Q3-2014 Q4-2014 Q1-2015 Q2-2015 Q3-2015 Q4-2015 Q1-2016 Q2-2016 Q3-2016

10 9 8 7 6 5 4 3 2 1 0 -1 -2 -3 -4

Gross domestic product

Gross domestic product of the business sector

We emphasize that the quarterly data must be viewed very cautiously because it is only the initial estimate, which is likely to be revised substantially in the coming months. On this regard, we note that the Central Bureau of Statistics (CBS) revised upwards the growth rates in the first two quarters of the year. Thus, the revised growth figure for the first quarter of this year stands at 3.2%, substantially above the initial estimate of only 0.8% (in annualized terms), and the revised growth figure for the second quarter stands at 4.9%, compared to the initial estimate of 3.7%. As can be seen in the accompanying chart, these are relatively rapid growth rates that are above the quarterly average growth rate from the past two years (2014-2015), equaling 2.7% (in annualized terms). In light of the above, Bank Leumi's 2016 growth forecast is expected to be revised upwards to 3.0% - 3.5%, which is higher growth than that registered in the two preceding years (and compared to the preceding 2.8% growth forecast). In light of the relatively rapid population growth in Israel, the GDP growth figure reflects an annual per capita growth rate of 1.0% BANK LEUMI LE-ISRAEL, THE FINANCE DIVISION The Economics Sector, P.O.Box 2, Tel Aviv 61000

Ph: 972-76-885-8737, Fax: 972-77-895-8737, e-mail: [email protected] http://english.leumi.co.il/Home/

1.5%, which is similar to growth in Europe and in most developed countries. However, it should be noted that Israel's GDP per capita is 40% below that in the US, and 30% below that in western European countries. Thus, in order to narrow the gap in the standard of living between Israel and OECD countries, the GDP per capita in Israel must return to growth at a substantially faster pace than that of the developed countries, as was the case up until 2011. Increases were registered in most GDP components in the third quarter of the year Analysis of the GDP components in the third quarter of the year indicates an increase in most components, while private consumption (accounting for 60% of GDP) continues to be the principle, stable engine of growth for the economy, similar to the trend in recent years in which Israeli goods exports were weak.

Gross Domestic Product components Constant prices, seasonally adjusted data, index - 100=Q1/2011 145 140 135 130 125 120 115 110 105 100 95 90 85 80

Private consumption Residential buildings Exports of services

Machinery and equipment Exports of goods

As can be seen in the accompanying chart, private consumption has shown stable growth since the beginning of 2011; however, it must be noted that private consumption increased at a more moderate rate in the third quarter of this year compared to the first half of the year. This comes against the backdrop of a sharp increase in purchases of durable goods (which are import intensive), primarily automobiles. At the same time, the rapid increase in investment in fixed assets continued, against the backdrop of a sharp increase in investments in the industrial sectors, expressed in an increase imported machinery and equipment that is reflected in the continued rise in the import of goods and services. We note that the increase in investments in the industrial sectors occurred, at least partially, against the backdrop of a notable investment on the part of the Intel Corporation due to its expansion of activities in Israel; and consequently, it is possible that the increase in investments is temporary and will cease during 2017. However, Intel's expansion of activity in Israel, when the expansion of the company's facility in the south of the country will be completed, apparently during 2017, is expected to begin to contribute to an increase in GDP by means of an increase in exports in the years 2017-2018.

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_________________________________________________________________ BANK LEUMI LE-ISRAEL, THE FINANCE DIVISION

At the same time, the increase in residential construction is continuing. On the other hand, the net export component (exports minus imports) continued to offset the growth rate also in the third quarter of the year, this as a result of a decline in the export of goods and services, and an increase in imports. In summary, the growth data show economic activity is dependent on local demand, to a much greater degree than external demand. Until there is a recovery in global trade, and steps will be implemented that will contribute to a change in the trend of Israeli exports (primarily of goods), in particular an improvement in the challenging business environment as expressed in Israel's relatively low rating in the index on the ease of doing business (52), it can be expected that private consumption in Israel will continue to be the primary growth engine of the economy. The "inflation environment" is expected to climb to the lower border of the price stability target range (1%) towards the second half of 2017 The consumer price index (CPI) for October increased 0.2%, this following two consecutive months of declines. Despite the increase, the "inflation environment", which is calculated from actual developments in prices during recent months as well as over the past year, and also from expected developments for the coming year, remains very moderate. Over the past 12 months the CPI declined 0.3% (October 2016 compared to October 2015). Excluding the impact of the housing component, which is based on prices in renewed housing rental contracts, the CPI fell by a substantial rate of 1.1%.

Consumer Price Index Y-o-Y Rate of Change 5.0% Forecast

4.0% 3.0% 2.0% 1.0% 0.0% -1.0% -2.0%

Next 12 months

Past 12 months

Increased prices in the food, fruits and vegetables, and the clothing and shoes components contributed to the rise in October's CPI. On the other hand, a 0.4% decline was registered in the sub-component involving owned dwellings services (reflecting housing rental prices in renewed contracts). However, the annual rate of increase of rental prices (the rate of change over the last 12 months) increased slightly to 2.2% compared to 2.0% and 2.1% in the two preceding months. Looking forward, the housing component (based on housing rental prices) is expected to continue to be the dominant factor behind the rise in prices within the CPI. 3

_________________________________________________________________ BANK LEUMI LE-ISRAEL, THE FINANCE DIVISION

In our opinion, the "inflation environment" is expected to climb gradually and to reach to around the lower border of the government's price stability target range (1%-3%) during the second half of 2017 (see accompanying chart). This development represents a necessary condition, in combination with other factors, such as a number of interest rate hikes in the US and continued positive development in the local economy growth data (as explained in the sections above), for an initial interest rate hike by the Bank of Israel (BoI). Such a move by the BoI is expected to occur during the second half of 2017. In October the unemployment rate for the primary working age category (ages 25-64) fell to a low of 3.9% In October this year the unemployment rate for persons aged 15 and above fell to an historical low of 4.5%, compared to 5.0% in the preceding month (seasonally adjusted data). This drop was supported by a decline in the workforce participation rate to 64.1% compared to 64.4% in September. This was the result of a decline of 17,000 in the number of unemployed persons – the sharpest decline since October 2014 – while at the same time the number of employed persons increased. On this regard, we note that the number of employed persons in full-time positions increased by 27,500 in October, alongside a decline in the number of employed persons in part-time positions, similar to the trend since the beginning of the year. However, as a result of the fewer number of work days in October, due to local holidays, the sampling rate of the CBS of survey participants was below the average; therefore, the data must be looked at very cautiously. Unemployment and Workforce Participation Rates (25-64) Monthly data, Seasonally adjusted, % 80.5 80

6

79.5

5.5

79 5 78.5 4.5

78

4

Participation rate, %

Unemployment rate, %

6.5

77.5

3.5

77

Unemployment rate - left axis

Participation rate - right axis

For the primary working age category (ages 25-64), which has the largest impact on the labor market and consequently also on local demand (primarily due to its proportion of the total workforce and its higher wages compared to younger working aged persons), the unemployment rate fell to a very low level of 3.9%, compared to 4.2% in the preceding month. At the same time, the workforce participation rate for this category declined slightly to 80.1% compared to 80.2% in September (see accompanying chart). This comes against the backdrop of a decline in the number of unemployed persons, whereas the number of employed persons increased by 18,300. 4

_________________________________________________________________ BANK LEUMI LE-ISRAEL, THE FINANCE DIVISION

In summary, October's employment data indicate a decline in the number of employed persons who are not from the primary working age category, that is to say, primarily persons younger than 25 years old. The average income level of these people is lower than that of employed persons within the primary working age category (25-64). On the other hand, the number of employed persons aged 25-64 increased, together with an increase in full-time positions and a decline in part-time positions. These are positive developments that support a continued rise in private consumption in the economy also in the coming months. In our opinion, the unemployment rate in the economy fell this year to an average of 4.9%, compared to 5.3% in 2015. Towards the coming year we do not expect a substantial change in this level.

Author:

Yaniv Bar

The data, information, opinions and forecasts published in this publication (the “Information”) are furnished as a service to the readers and do not necessarily reflect the official position of the Bank. The above should not be seen as a recommendation and should not replace the independent discretion of the reader, nor should it be considered an offer or invitation to receive offers or advice – whether in general or in consideration of the particular data and requirements of the reader – to purchase and /or to effect investments and/or operations or transactions of any kind. The Information may contain errors and is subject to changes in the market and to other changes. Likewise, significant discrepancies may arise between the forecasts contained in this booklet and actual results. The Bank does not undertake to provide the readers with notice, in advance or in retrospect, of any of the aforementioned changes by any means whatsoever. The Bank and/or its subsidiaries and/or its affiliates and/or the parties controlling and/or parties having an interest in any of them may, from time to time, have an interest in the information represented in the publication, including in the financial assets represented therein.

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_________________________________________________________________ BANK LEUMI LE-ISRAEL, THE FINANCE DIVISION