The Bank of Israel is facing a challenging economic environment, characterized by rising inflation and persistent geopolitical risks. Deputy governor Andrew Abir recently stated that the central bank is unlikely to lower short-term interest rates in the remaining policy meetings of 2024. This decision comes at a time when concerns about inflation, fueled by the ongoing Gaza war and fears of a regional conflict, are at the forefront of policymakers’ minds. Despite previously easing rates by 25 basis points in January, the bank has maintained its benchmark interest rate at 4.5% for the fifth consecutive decision.
The inflation rate in Israel has risen to 3.2%, above the central bank’s target range of 1%-3%. It is expected to exceed 3.5% in the coming months, partly due to a planned increase in the value-added tax at the beginning of 2025. Deputy Governor Abir emphasized the importance of seeing progress in bringing inflation back down into the target range. The inflationary pressures are mainly coming from the supply side, with factors such as a shortage of workers contributing to the price increases. The ongoing conflict in Gaza has disrupted key industries, leading to a decrease in investments, particularly in construction.
Abir highlighted the need for caution in lowering interest rates, as doing so could widen the gap between demand and supply, potentially leading to further price increases, particularly in housing costs. Despite the modest growth of 1.2% in the economy during the second quarter, lowering rates in a period of uncertainty and geopolitical risk may not be the most prudent decision. Investors are seeking a higher rate of return under such circumstances, and reducing interest rates could exacerbate the situation, potentially resulting in a depreciation of the currency.
The geopolitical risks in the region, including the ongoing conflict with Hezbollah and Iran, are contributing to the volatility of the Israeli shekel. The currency has recently gained strength against the dollar, reflecting concerns about an all-out war and the anticipated rate cuts by the Federal Reserve. Additionally, the fiscal implications of the conflict have heightened the budget deficit, making it challenging to create a credible state budget for 2025. The government’s delay in implementing necessary spending cuts and tax increases has further complicated the situation, prompting the central bank to adopt a more cautious approach to monetary policy.
The Bank of Israel is navigating a complex economic landscape characterized by rising inflation, geopolitical risks, and fiscal challenges. Deputy Governor Abir’s remarks highlight the importance of data-driven decision-making in determining the future path of monetary policy. As the central bank continues to monitor the evolving situation, striking a delicate balance between supporting economic growth and managing price stability remains paramount in ensuring a stable and sustainable economic environment for Israel.