Bank of Israel again leaves interest rate at 4.5%, amid wartime fiscal uncertainty
Central bank raises concern over the government’s expansionary fiscal policy and a widening deficit due to the war and the delay in the 2025 budget
Sharon Wrobel is a tech reporter for The Times of Israel.
The Bank of Israel on Monday opted to leave borrowing costs unchanged for a fifth straight time, citing heightened geopolitical and fiscal uncertainty amid the ongoing war with the Hamas terror group that has been raging for more than 10 months.
“Since the outbreak of the war, and in recent months in particular, geopolitical uncertainty and its economic ramifications have increased,” the central bank said in a statement. “The uncertainty surrounding the state budget for 2025, and the implementation of adjustments required to reduce the deficit on an ongoing basis, contributes to an increase in the risk premium and is liable to weigh on the return of inflation to its target.”
Bank of Israel Governor Amir Yaron has in recent weeks expressed concern over the government’s management of its expansionary fiscal policy to fund growing defense and civilian expenditure during the ongoing war with the Hamas terror group. Earlier this month, Yaron urged Prime Minister Benjamin Netanyahu to advance the approval of the 2025 state budget and make responsible spending cuts to preserve fiscal discipline and credibility. Discussions with the government on the 2025 state finances have stalled in recent weeks, however.
The central bank decided to hold interest rates at 4.5 percent, in line with forecasts by most economists. Ahead of the decision, economists were not split about whether policymakers would make a change to the interest rate level, but rather over whether there would be one reduction at the very end of the year, or none at all, amid uncertainty over the risk of an escalation of the fighting to an all-out-war.
Meanwhile in the US, expectations for multiple interest rate cuts by the end of the year are increasing, and the European Central Bank is also expected to lower borrowing costs further.
“The decision to keep interest rates steady was expected in light of the latest indicators and the increase in the annual inflation rate, which has breached the ceiling defined by the Bank of Israel,” said Dror Ohev Zion, founder and CEO of residential project marketing and sales agency Dar. “The breach is a result of the government’s irresponsible fiscal conduct which causes great damage to the Israeli economy and businesses in general.”
In January, the Bank of Israel cut the base lending rate for the first time in almost four years by 25 basis points from 4.75% to 4.5% to support households and businesses as the economy was getting battered due to the war and with the inflation environment easing. Since then, inflation has been on an upward trend. In July, Israel’s annual inflation rate accelerated above the 1-3% target range to 3.2% from 2.9% a month earlier.
“The Bank of Israel, in our view, will attach higher weight to higher inflation news rather than to soft growth news,” JP Morgan economist Anatoliy Shal said in a research note before the rate call. “We therefore think that the Bank of Israel will continue to err on the side of caution near term, especially as the geopolitical environment remains tense, and don’t anticipate cuts at the next couple of meetings.”
Israel is in its 11th month of a war with Hamas, which began October 7 when thousands of terrorists streamed into Israel to murder some 1,200 people, mostly civilians, while taking 251 hostages to Gaza. Alongside the war in Gaza, fears of an all-out war between Israel and Hezbollah in Lebanon have intensified in recent weeks after a series of high-profile strikes Israel has carried out on the Iran-backed terror group.
War costs have already driven up defense and civilian spending, leading to a fiscal shortfall of 8.1% of gross domestic product in July. The government has set an annual budget deficit target of 6.6% for the end of 2024. The central bank said it still expects 2024 to end with a budget deficit of 6.6%, “to the extent that there won’t be additional unexpected additions to the defense budget,” it said.
“In comparison with the previous interest rate announcement, the central bank this time put fiscal uncertainty at the top of the agenda,” said Mizrahi Tefahot Bank chief markets economist Ronen Menachem. “The Bank of Israel is providing a clear signal to the market that in the current situation, if the uncertainty is not removed, it will be difficult for borrowing costs to come down.”
At the previous interest rate decision in July, the central bank trimmed its growth forecast for the economy. In 2024, the economy is expected to grow by 1.5%, and next year by 4.2%. That is down from a previous forecast in April of 2% in 2024 and 5% in 2025.
Israel’s economy grew at a much slower pace in the April to June period, falling short of economists’ forecasts, as the war with Hamas continued to take a heavy toll on exports and investments. It expanded at an annualized 1.2% in the April to June period from the previous three months, and was down 1.4% in comparison to the corresponding quarter last year.
“Current indicators of the state of economic activity point to continued moderate growth of activity in July–August,” the central bank said.
