The Bank of Israel on Monday increased the benchmark interest rate for the seventh straight meeting, raising its key lending rate by 50 basis points to 3.75 percent, the highest level since 2008, as the central bank steps up efforts to tame the rising inflation of recent months.
The central bank’s monetary committee decided to lift the benchmark rate to 3.75% from 3.25%, in line with most economists’ forecasts. Since policymakers started to raise borrowing costs in April from an all-time low of 0.1%, the key lending rate increased by more than 300 basis points in 2022, as the Bank of Israel seeks to bring inflation back into the government’s 1% to 3% target range.
Despite the steps, Israeli inflation accelerated to 5.3% in November, over the previous 12 months, led by spiraling housing and food costs.
“High inflation involves growing uncertainty and increasing difficulty in making decisions at the household and the business levels, weighs on economic conduct, and adversely impacts growth and welfare, first and foremost among the weaker strata,” said Bank of Israel governor Amir Yaron in remarks delivered at a press conference on Monday in Jerusalem. “In addition, the more entrenched inflation becomes, the harder it is to eradicate, and then ultimately the required interest rate will be even higher.”
Yaron welcomed the new incoming government and, acting as the economic adviser to the government, warned about the potential risk of exuberant budget demands made by its coalition partners. The deals signed with far-right and Haredi partners are slated to increase welfare payouts for the ultra-Orthodox, whose employment rate is low.
“Soon, budget discussions will begin, concrete proposals will be placed on the table, and the government’s intentions will be clarified,” said Yaron. “It is important that the new government acts with the necessary responsibility with regard to fiscal policy, in particular regarding new expenditures that are not geared towards promoting sustainable growth.”
In his first act in office, Finance Minister Bezalel Smotrich instructed ministry officials on Sunday to roll back tax hikes on single-use plasticware and sweetened drinks. The removal of the charges will cause an annual loss of NIS 1.2 billion ($340 million) in tax earnings for the treasury.
“I have said in the past that one of Israel’s strategic assets is the low debt to GDP ratio of its economy, which served us well in the COVID-19 crisis,” Yaron emphasized. “It is important to remember that the Israeli economy cannot take for granted the high regard from the rating entities and international financial institutions.”
“As a small and open economy that interacts with the largest economies in the world, the continued trust of the markets and of the various entities in the global economy is very important to the Israeli economy and to the existence of a financial and business environment that is stable and secure,” he said.
The Bank of Israel cited strong economic activity of the Israeli economy, a tight labor market and the rising inflation environment as the main reasons for lifting its key lending rate.
“Economic activity in Israel remains strong, but the growth rate appears to have slowed relative to the first half of 2022,” the central bank stated. “The labor market remains tight, although in recent months there has been some moderation in employment data.”
In its statement, the central bank noted that housing prices have increased at a significantly high rate in the past 12 months, surging 20.3%. Meanwhile, the number of building starts and permits remain higher than in the past, and the number of home purchase transactions and the volume of mortgages taken out continue to decline, the Bank of Israel said.
“Although home prices continue to increase at a very high pace, data on building starts, permits, the number of transactions carried out, and new mortgage volume support a moderation in the market,” said Yaron. “It may be assumed that these factors, to the extent that they continue, will be reflected in prices later on.”
Yaron remarked that inflation pressure is expected to continue in the coming two months, while the central bank’s monetary committee pointed to first signs of a slowdown in the dynamic of price growth.
“The continuing downward trend in the price of oil, in view of the decline in global demand, and the easing of the supply chain difficulties are expected to continue working to lower the prices of tradable goods, but with some lag and depending on developments in the exchange rate,” the central bank said.
Alongside the interest rate decision announcement, the Bank of Israel’s research team on Monday also revised its forecast of economic indicators. Central bank economists now expect the inflation rate to ease to 3% over the coming year, versus 2.5% forecasted in October, and move to 2% in 2024. The economy is expected to grow at an annual rate of 2.8% in 2023, revised down from 3% forecasted in October, and by 3.5 percent in 2024.
“The upward revision of the inflation forecast for 2023 was impacted primarily by the depreciation of the shekel and by expectations regarding wage increases that will be determined in public sector wage agreements,” according to Bank Leumi chief economist Gil Bufman.
Since the last interest rate decision in November, the shekel weakened by 1.6% against the US dollar, and by 5.8% against the euro, the central bank wrote in its statement.
Looking ahead, the bank’s research department sees room for further interest rate increases with the key lending rate forecasted to reach 4% in the coming year, up from 3.5% in its prior estimate.