The Bank of Israel has made it clear that they do not intend to lower short-term interest rates at their remaining two policy meetings in 2024. This decision comes as a result of rising price pressures and ongoing geopolitical risks. Despite holding the benchmark interest rate at 4.5% for five consecutive decisions, concerns about inflation mounting to a rate of 3.2% and the persistent Gaza war are major factors influencing this stance. While the bank did reduce interest rates by 25 basis points in January, they have since maintained a steady rate to combat the current economic challenges and uncertainties.
Deputy governor Andrew Abir expressed skepticism about any rate cuts until well into 2025. Abir emphasized that the decision to lower rates is contingent on the incoming data and economic developments. The uncertainty surrounding the ongoing war and the disruptions in key industries make it difficult for the Bank of Israel to consider decreasing interest rates. Policymakers are scheduled to meet next on Oct. 9, followed by Nov. 25 and Jan. 6, 2025. The inflation rate in Israel is projected to exceed 3.5% in the upcoming months due to factors such as the planned increase in value-added tax at the beginning of 2025. However, Abir stressed the importance of seeing progress in bringing inflation back down to the target range of 1%-3% after its temporary rise.
Abir pointed out that much of the inflationary pressure is originating from the supply side. Factors such as the shortage of workers, restrictions on Palestinians entering Israel, military service commitments, and the displacement of Israelis due to Hezbollah rocket attacks in the north are contributing to the inflationary challenges. The prolonged duration of the war has led to significant shocks in the real economy, causing investments, especially in the construction sector, to decline substantially. Lowering interest rates at this juncture could exacerbate the imbalance between demand and supply, leading to further price hikes, particularly in housing costs.
Abir highlighted the potential consequences of reducing interest rates in a period marked by uncertainty and geopolitical risks. Investors typically seek higher returns during such times, and lowering rates may not align with their expectations. This misalignment could result in a depreciation of the currency, which has already shown signs of volatility. Although the shekel has gained 3% against the dollar recently amidst expectations of a full-scale conflict with Hezbollah or Iran and potential U.S. rate cuts by the Federal Reserve, the decision to lower rates remains cautious.
The fiscal situation in Israel is another critical factor influencing the monetary policy stance. The war has widened the budget deficit, prompting concerns about the government’s delays in devising a credible 2025 state budget that involves necessary spending cuts and tax adjustments. This fiscal uncertainty has compelled the central bank to exercise caution and adopt a conservative approach towards monetary policy decisions. Abir reiterated the importance of aligning fiscal and monetary policies to ensure stability and sustainable economic growth in the long run.
The Bank of Israel’s reluctance to lower interest rates reflects a prudent approach to managing the current economic challenges and geopolitical uncertainties. By prioritizing stability, inflation control, and fiscal responsibility, the central bank aims to navigate through the complexities of the ongoing crisis while safeguarding the long-term economic well-being of Israel.