(Communicated by the Bank of Israel)

• Economic activity during the reviewed period continued to grow at a moderate pace. The growth rate during the second quarter of 2012 was 3.4 percent, lower than the economy's long-term growth rate and near a rate consistent with Bank of Israel's forecast for 2012. (The forecast was for a growth rate of 3.1 percent; the average growth rate since the beginning of the year is 3.24 percent.)

• The slowdown in economic activity derives from weaker growth in demand against the background of the slowdown in global economic activity. The global environment during the reviewed period was characterized by the risk of an economic crisis in Europe, following the debt crisis in a number of eurozone countries and its ramifications on the rest of the eurozone and the rest of the world.

• The Bank of Israel's monetary policy responded to the continued moderate activity in a measured way, by reducing the July interest rate by 0.25 percentage points, against the background of the low interest levels in the economy, along with four additional factors: (1) the weakness of the shekel, which helped the Israeli economy deal with the slowdown; (2) inflation expectations for the coming year, which were around the center of the target range; (3) uncertainty regarding fiscal policy at the beginning of the reviewed period, which limited maneuverability in monetary policy; and (4) concern over continued increases in home prices. Assessments of state revenue from taxes, upon which the government's budget is structured, were based on a growth rate that was higher than actual growth. As such, the government deficit was larger than expected. Toward the end of the reviewed period, the government of Israel made a decision taking into account both the risks inherent in increasing the deficit and the risks inherent in harming demand: The government deficit target was increased to 3 percent, while VAT rates were increased by one percent, income tax on monthly income in excess of NIS 14,000 was increased by one percent, tax brackets where changed, and a wide-ranging cut to expenses was decided upon in order to finance the increase in expenses in certain items in accordance with government decisions. These decisions are expected to increase the government's revenue from taxes and to contribute to a reduction in the deficit target.

• According to Bank of Israel estimates, home prices are in accord with the level of demand, supply, and interest rates in the market. With that, it should be noted that that mortgage volume data indicated a return of buyers to the housing market, and this data in and of itself may create expectations of continued price increases. If these expectations are fulfilled, a price bubble may develop in the housing market. It is thus vital to track developments in this market and to handle extraordinary developments as necessary.

• Notwithstanding the recent slowdown, there are a number of indicators showing that there is a high level of activity in the economy, which may help the Israeli economy should a crisis erupt in Europe. The output gap that is estimated through various methods has been hovering for a long time around low values. The unemployment rate has been at 7 percent since the fourth quarter of 2011—a low level in historical terms. This low unemployment rate exists despite the fact that the participation rate in the labor market is at an all-time high of 63.6 percent. In parallel, there is an upward trend of 2 percent in real salaries since the beginning of 2010 (they are still 2 percent away from the all-time high levels prior to the crisis), and there is a high rate of available positions.

• The real exchange rate in the economy has indicated a prolonged depreciation since 2011 in light of the departure of foreign investors from the local market and in light of the increase in the trade deficit. The depreciation during the reviewed period is part of the depreciation that began at the start of 2011 and has taken place against the background of the limitations imposed on the foreign currency market in Israel, which has led to the departure of foreign investors from bills (makam) issued by the Bank of Israel. The weight of foreign investors among those holding makam was 35 percent at the beginning of 2011. With the imposition of the limitations, their proportion has declined to 2.5 percent in the reviewed period.