Bank of Israel keeps interest rates unchanged, says cycle of jumps may not be over

As forecast, central bank leaves borrowing costs at 4.75%, but cautions about impact of shekel depreciation on inflation and the possibility of further rate hikes

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

Bank of Israel Governor Amir Yaron speaks during a press conference in Jerusalem, on April 11, 2022. (Flash90/File)
Bank of Israel Governor Amir Yaron speaks during a press conference in Jerusalem, on April 11, 2022. (Flash90/File)

The Bank of Israel on Monday left the benchmark interest rate steady for a second month in a row as inflation showed signs of easing but warned about a “real possibility” of higher borrowing costs in coming months if the moderating path does not continue and the shekel weakens further.

The central bank held interest rates at 4.75 percent, as it did at its last decision on July 10, in line with the forecasts by the majority of economists. Steady rate hikes over the past year lifted borrowing costs from a record low of 0.1% in April 2022 as the Bank of Israel sought to bring down inflation that was hovering above 5%. The aggressive interest rate increases have been rapidly fueling the costs of mortgage and loan holders, many of whom are struggling to meet monthly payments.

“In recent months inflation appears to be slowing,” the central bank said in a statement. “Therefore, the Monetary Committee decided to leave the interest rate unchanged, but sees a real possibility of having to raise the interest rate in future decisions, if the inflation environment does not continue to moderate as expected.”

Annual inflation slowed to 3.3% in July from from 4.2% in June, its lowest rate in more than a year. However, consumer prices are still above the government’s target range of 1%-3%. Meanwhile, political uncertainty around the government’s proposed judicial overhaul has seen the shekel depreciate by more than 8% against the US dollar since the start of the year, leaving the local currency trading around NIS 3.81 to the dollar, its weakest level in about three years.

“Since the beginning of the year, the shekel has remained one of the weakest currencies in the world, while the volatility of the shekel exchange rate has remained high,” the central bank remarked.

During the month of August, the shekel lost 3.3% of its value versus the greenback. Depreciation in the local currency raises the price of imported goods such as food and gas, along with travel abroad, and leads to higher inflation.

Tech workers protest Israel’s right-wing government in Tel Aviv, on January 24, 2023. The Hebrew on the blue sign reads: ‘No democracy, no high tech; and the yellow sign reads: “No to the coup d’etat.’ (AP/ Maya Alleruzzo)

“The monetary tightening processes and the moderation of demand in Israel and abroad are working to moderate inflation,” the Bank of Israel noted. “In contrast, the depreciation of the shekel in recent months is contributing to an increase in the pace of inflation, and the path of the exchange rate in the coming months will have an impact on inflation dynamics.”

Commenting on the rate decision, Bank Leumi chief economist Gil Bufman said that further shekel devaluation is a factor that may support another interest rate hike further down the road or postpone the date for the start of lowering borrowing costs.

Bank of Israel governor Amir Yaron, who is due to end his term at the end of 2023, has been critical of the advancement of the judicial overhaul in its proposed format, warning about its economic repercussions. Yaron’s stance has raised doubt in recent weeks among financial market participants if he would ask to extend his tenure and whether lawmakers would want to reappoint him.

Earlier reports on Monday by Army Radio that Yaron would announce he will not seek another term were promptly denied. The central bank issued a statement reiterating that Yaron will make his decision public on whether he would ask to stay on for a second five-year term closer to the Jewish holidays, which are mid-September to October.

In recent months, Yaron cautioned that weakness in the local currency due to uncertainty around the contentious judicial overhaul has led to “excess” inflation of at least 1% to 1.5%, while indicating that if the trend continued the central bank would need to raise borrowing costs to rein in price growth.

The market is now pricing in a 40% probability of another interest rate hike at the central bank’s next announcement scheduled for October 23, in line with his bank’s estimate, Bank Hapoalim chief strategist Modi Shafrir said in an emailed report.

Israelis set up tents on Rothschild Boulevard in Tel Aviv, to protest against the soaring housing prices in Israel and social inequalities, on June 19, 2022. (Tomer Neuberg/Flash90)

Last month, the Bank of Israel said that uncertainty around the advancement of the proposed judicial shakeup was already having an impact on the economy reflected in the increase in the country’s risk premium, depreciation of the shekel, the decline in equity prices, and increased volatility in the foreign exchange market.

For now, the Bank of Israel sees the economy growing at a rate of 3% in each of the years 2023 and 2024. As the main risk to the forecast, the central bank cited a scenario in which the advancement of the legal and institutional changes leads to an increase in Israel’s risk premium, continued devaluation of the shekel, damage to exports, and a decline in local investments and demand for private consumption. Should this risk materialize, the central bank estimates that the damage to Israel’s GDP in each of the coming three years will be between 0.8% and 2.8%.

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