Amid ongoing war, Bank of Israel cuts borrowing costs for 1st time since April 2020

Governor urges government to make necessary budget adjustments to balance the increase in defense and civilian expenditures resulting from the campaign against Hamas

Sharon Wrobel is a tech reporter for The Times of Israel.

Bank of Israel Governor Amir Yaron speaks during a press conference at the Bank of Israel in Jerusalem, on January 7, 2019. (Noam Revkin Fenton/Flash90)
Bank of Israel Governor Amir Yaron speaks during a press conference at the Bank of Israel in Jerusalem, on January 7, 2019. (Noam Revkin Fenton/Flash90)

In a bold move, the Bank of Israel on Monday cut interest rates for the first time in nearly four years to help support households and businesses, with the economy getting battered due to the ongoing war with the Hamas terror group while the inflation environment is easing.

“It is clear to us that the adverse economic impact suffered by the economy is substantial…. Alongside that, we see recovery in overall economic activity,” said Bank of Israel Governor Amir Yaron. “This is an indication that the Israeli economy is succeeding in adjusting to the reality forced upon us.”

“The continued existence and encouragement of a return to routine to the greatest extent possible on the home front, against the backdrop of the war at the front with the required adjustments, is necessary and essential to the economy,” Yaron emphasized.

The central bank decided to lower borrowing costs by 25 basis points to 4.5 percent. The last time interest rates were reduced was in April 2020 during the coronavirus pandemic.

Ahead of Monday’s decision, economists were split, not if interest rates will come down, but over the timing of the move, with some expecting a first reduction in February, given the uncertainty over the duration and extent of the war.

Israel is almost three months into a war with Hamas, which began October 7, when some 3,000 terrorists streamed into Israel by land, sea, and air, and killed some 1,200 people, mostly civilians, while taking at least 240 hostages of all ages into Gaza.

Damage to a home hit by a rocket in Ashkelon, December 5, 2023. (Edi Israel/Flash90)

“Now that interest rates are trending downward, the consumer’s situation is expected to improve, as the monthly cost of loans such as mortgages or car loans will go down, leaving more money in the pockets of households,” said Psagot Investment House chief strategist Ori Greenfeld. “In addition, the decline in mortgage costs on the one hand and the halt of construction [due to the war and a shortage of workers] on the other, will probably lead to a renewed wave of price increases in the real estate market in the medium term.”

In the period since the outbreak of the war, Yaron said the central bank was focused on stabilizing markets and ensuring the orderly operation of the financial markets, before deciding over easing credit and loan costs for households and businesses.

Furthermore, the Bank of Israel’s main concern was to bring down rising inflation into the government’s price target range of 1% to 3%, by hiking interest rates from a record low of 0.1% in April 2022 to 4.75% in July.

The inflation rate has eased in recent months and slowed to 3.3% in November, while central bank researchers expect that the rate will return to its target already in the first quarter of this year and moderate to 2.4% by the end of 2024.

According to the central bank, the defense and civilian costs of the war will amount to a total of around NIS 210 billion ($58 billion), and are “certainly a budgetary burden,” Yaron said.

Going forward, the government will need to make budgetary adjustments of around NIS 30 billion, in order to offset the permanent increase in defense expenditures and civilian expenditures related to the war and its consequences, the Bank of Israel estimated. This includes spending on the rehabilitation of war-rampaged southern communities along the Gaza border, and an increase in government debt interest expenses.

Damage to a building in Sderot from a direct rocket strike, October 17, 2023. (Sderot Municipality)

In view of these costs, Yaron reiterated his appeal to the government to make adjustments in the 2024 state budget by cutting all non-war related expenditure, while focusing on the kinds of spending that are growth drivers for the economy.

“I would like to say as clearly as possible: not acting now to adjust the budget via cuts in expenditures, removing redundant ministries and increasing revenues in view of the needs of the war is likely to cost the economy much more in the future,” warned Yaron. “The cost will be reflected not only in the areas of the budget and the deficit, but is liable to have a negative impact on additional economic processes.

“Therefore, what is needed now is a responsible budget, [a condition] required for the Israeli economy’s return to its high potential growth,” he added.

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