Bank of Israel holds borrowing costs steady, citing rising geopolitical uncertainty

The Bank of Israel on Monday decided to side with caution and left interest rates steady amid the ongoing war with the Hamas terror group, growing geopolitical uncertainty, and a weaker shekel.

The central bank held interest rates for a second consecutive meeting at 4.5 percent. Back in January, it cut the base lending rate for the first time in almost four years by 25 basis points, from 4.75%, to support households and businesses as the economy was getting battered, due to the Hamas war, and as the inflation environment was easing.

“Geopolitical uncertainty remains high, and recently has been increasing,” Bank of Israel Governor Amir Yaron said at a press conference in Jerusalem. “Despite the gradual improvement in economic activity, there is a long way to go before the economy fully recovers.”

“As long as we see the geopolitical uncertainty modulate and stabilize, and inflationary pressures ease, we can return to a path of lowering borrowing costs,” Yaron remarked.

Following the rate call, Israel Discount Bank chief economist Nira Shamir said she expects borrowing costs to be cut to 4% by the end of 2024 and to 3.75% over the coming 12 months.

Ahead of the decision, economists were split on whether interest rates would come down further or remain steady, as the shekel weakened amid heightened regional tensions and threats by Iran to respond to the alleged assassination by Israel of the top Islamic Revolutionary Guard Corps officer in Syria.

First responders at the site where a rocket fired from Gaza hit a building in Rishon Lezion, October 25, 2023. (Yossi Aloni/Flash90)

Israel is in its seventh month of war with Hamas in Gaza, which broke out in response to the terror group’s October 7 massacre in southern Israel, in which close to 1,200 people, mostly civilians, were slain, and 253 were kidnapped to Gaza, where more than half are believed to remain.

Geopolitical tensions in the region have been high since an alleged Israeli strike in Damascus last week killed seven IRGC members, among them a senior Quds Force commander, Brigadier General Mohammad Reza Zahedi.

The Iran-backed Hezbollah has said it supports Iran’s right to “punish” Israel, and in televised remarks on Friday, its leader, Hassan Nasrallah, said a response was coming.

Among the risks cited by Yaron for a possible acceleration of inflation were: the impact of the war on economic activity, a depreciation of the shekel, a downturn in the construction industry, and higher fiscal spending as defense costs rise.

“High inflation creates increasing difficulty for households and businesses and adversely impacts weaker groups, first and foremost,” said Yaron.

Since the previous interest rate decision on February 26, the shekel weakened by about 2.7% against the dollar, and by about 2.6% against the euro, the central bank said.

The central bank’s research department expects the economy to grow by 2% in 2024 and by 5% in 2025, similar to its January forecast. The growth projection assumes that the economic impact of the war will be limited to the end of 2024 and will take place on just one front.

“For 2025, the assumption is that there will not be additional direct effects from the combat,” the central bank said.

Due to the rising costs of the war, the central bank’s research department raised its 2024 forecast for the state budget deficit to 6.6% of gross domestic product (GDP) from 5.7% previously.

Israel’s fiscal deficit grew to 6.2% of GDP in March, according to preliminary figures released by the Finance Ministry on Monday. The deficit rose from 5.6% in February and 4.8% in January, given increased military and civilian spending.

Israel, which posted a budget deficit of 4.2% in 2023, has set a deficit target of 6.6% of national output for 2024.

Times of Israel staff contributed to this report.