Bank of Israel holds interest rates amid concerns over Iran escalation

The Bank of Israel on Monday left interest rates on hold at four percent as heightened fears over potential hostilities with Iran took precedence over lower borrowing costs for households and businesses.

“Geopolitical uncertainty has resurfaced in recent days, in view of a potential confrontation with Iran,” the central bank said. “There still remain several risks for a renewed increase of inflation: geopolitical developments and their impact on economic activity, an increase in demand alongside supply constraints, and fiscal developments.”

US and Iranian diplomats are expected to meet in Geneva on Thursday for a third round of talks over Tehran’s nuclear ambitions, while the US continues to amass forces in the Middle East for a possible strike. Iran has threatened that, if the US attacks, it will respond with strikes on US military interests in the region and on Israel.

In January, the central bank cut borrowing costs by 25 basis points from 4.25% to 4%. In its previous rate decision in November, it had lowered the benchmark lending rate for the first time in almost two years to 4.25% from 4.5%, following a ceasefire agreement with the Hamas terror group.

Finance Minister Bezalel Smotrich slammed Bank of Israel Governor Amir Yaron for leaving interest rates unchanged, calling it a “wrong decision.” Smotrich urged Yaron to reverse the decision and continue the trend of lowering borrowing costs. Over the past year, Yaron has come under fierce criticism by politicians and manufacturers for hesitating to lower high borrowing costs.

“The decision to keep interest rates high is wrong and is not supported by the macroeconomic data of the Israeli economy,” Smotrich wrote in a post on X. “The shekel is strong, inflation is weakening, and has moved well within the government’s target range.”

“The main challenge today is growth and we need to ease conditions for Israeli citizens, households, mortgage holders, and small and medium-sized businesses…as credit is choking the economy and delaying a recovery,” said Smotrich.

The Israel Manufacturers’ Association expressed its “deep disappointment” in the central bank’s decision. The association cautioned that the 15% appreciation of the shekel against the dollar over the past nine months is harming exporters’ competitiveness and damaging the industry and the high-tech sector. Exports account for as much as 40% of Israel’s economic activity.

“The central bank is ignoring the greatest strategic danger currently facing the Israeli economy — the loss of competitiveness of industry and high-tech,” warned Israel Manufacturers’ Association President Avraham Novogrotzky. “Failing to cut the interest rate at this stage puts more pressure on exporters and deepens the damage to productive activity in the economy.”

“A high-interest environment increases financing costs for factories, harms the viability of new investments in equipment, technology, and the expansion of production lines, and especially burdens small and medium-sized factories, which constitute the backbone of Israeli industry,” Novogrotzky added.

Ahead of the decision, economists were split over whether the central bank would reduce interest rates in light of inflation coming down in recent months and a strong shekel, or pause amid rising geopolitical risks in recent days.

Leader Capital Markets chief economist Jonathan Katz, who expected the central bank to keep borrowing costs steady “due to possible escalation with Iran and very robust growth,” predicted that credit costs will be cut gradually to 3%-3.25% by the end of 2026.