Central bank cuts growth prospects, holds rates as war expected to last into 2025
Bank of Israel Governor Amir Yaron urges the government to act on passing the 2025 budget with responsible austerity measures and policies to uphold the ‘economy’s robustness’
Sharon Wrobel is a tech reporter for The Times of Israel
The Bank of Israel sees slower growth for this year and next, as it expects the war with the Hamas terror group and the intensified fighting with Iran-backed Hezbollah to last well into 2025, taking a heavy toll on the country’s finances and the economy.
“The war has significant economic ramifications, and the path back to routine full activity of the Israeli economy still lies ahead of us,” said Bank of Israel governor Amir Yaron at a press conference in Jerusalem. “We are facing notable economic challenges, and dealing with them requires conducting responsible economic policy, both fiscal and monetary, in order to ensure the continued financial robustness and economic growth in the future.”
The central bank now expects the economy to grow by 0.5 percent in 2024, and 3.8% in 2025. That forecast was revised from a previous growth projection in July of 1.5% in 2024 and 4.2% in 2025, when the central bank assumed that intense fighting with Hamas would abide by the end of the year.
The central bank’s researchers said the trimmed growth forecast for 2025 “reflects more intense fighting in early 2025 (relative to the assessment in the July forecast) and a delay in the gradual recovery of economic activity to the second half of 2025.”
The Ministry of Finance, which lowered its growth projection last month, sees the economy expanding by 1.1% in 2024 and 4.4% in 2025.
Alongside the revised growth forecasts, the central bank decided to hold the benchmark interest rate at 4.5% for a sixth consecutive meeting, citing a broad increase in the pace of inflation and a weakening shekel. The move was in line with forecasts by most economists ahead of the decision.
In January, the central bank lowered borrowing costs 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 at the onset of the outbreak of the Hamas war, and as the inflation environment was easing.
Direct war costs have ballooned to an estimated NIS 250 billion ($66 billion) since October 7, 2023, when Hamas terrorists invaded Israeli southern communities, killing some 1,200 people, mostly civilians, and taking 251 as hostages into the Gaza Strip. Since October 8, Iran-backed Hezbollah terror forces have attacked Israeli communities and military posts along the northern border on a near-daily basis, with the group saying it is doing so to support Gaza amid the war there.
Last week, Iran fired a massive salvo of some 200 ballistic missiles at Israel after the IDF carried out a series of strikes against Hezbollah in Lebanon, including the assassination of its longtime leader Hassan Nasrallah.
“Due to the deterioration in the north, Israel’s risk premium, (…), increased sharply,” said Yaron. “A risk premium that is at a high level involves higher financing costs, in both the public and private sectors, and is liable to reduce investments and to impact negatively on economic growth.”
The central bank’s revised growth projections come after two major credit rating agencies, S&P and Moody’s, recently downgraded Israel’s credit rating, as both see the ongoing war lasting well into 2025, accelerating the economic fallout, putting further pressure on state coffers and leading to a slower recovery than previously estimated.
S&P cut its growth forecasts to 0% for 2024 and 2.2% in 2025 from 5% previously. Moody’s projects GDP growth of 0.5% this year, and lowered its expectation for next year to just 1.5%, from 4% previously.
Yaron urged policymakers to “pay attention and take the assessments of the rating agencies seriously, as they reflect the challenges and risks faced by the Israeli economy as the world sees it.” That’s as Finance Minister Bezalel Smotrich has been downplaying the impact of the rating downgrades over the past year on investments and the economy.
“The trust of the markets and international economic institutions is essential for the stability of the Israeli economy,” he emphasized.
To ensure the continued trust of the financial markets and investors in the Israeli economy, Yaron called on the government to act and make progress on passing a responsible budget for 2025, with the required fiscal adjustments that total NIS 30 billion, and deal with economic issues.
“It is important that the government and Knesset approve significant fiscal adjustments of a permanent nature, in contrast to the consistent increase in defense expenditures,” said Yaron. “From the perspective of the composition of the budget, the adjustments should be spread out over as broad a population as possible, and it is important that the government prioritizes growth-supporting expenditures, reduces negative incentives for going out to work, and eliminates non-essential ministries.”
Due to higher costs to fund the prolonged war, the central bank now expects the government to run a budget deficit of 7.2% of GDP in 2024. That’s above the government’s budget deficit target of 6.6% set for the end of this year. Ballooning war costs have already led to a fiscal shortfall of 8.3% of GDP in August.
Despite dwindling growth expectations, a change in interest rates is off the table over the coming year due to rising consumer prices, a weaker shekel and an expansionary fiscal policy to fund the war, according to central bank projections.
Commenting on the direction of the future interest rate path, Yaron said that it will be dependent on “data and developments.”
Over the past year, the war bolstered defense and civilian spending and pushed up the cost of fresh produce and travel abroad as many foreign airlines stopped flying to Israel, leading to higher consumer prices. Israel’s annual inflation rate accelerated to 3.6% in August, which is way above the government’s target range of 1% and 3%.
The increase in the prices of fruit and vegetables is mostly due to a shortage of supply as the bulk of Israel’s agricultural heartlands are located around the war-torn Gaza envelope and in the north along the border with Lebanon, where many residents, including farmers, have been evacuated. In addition, Palestinian workers, who make up a large part of Israel’s agricultural workforce, have not been able to return to their jobs since the war started.
For the coming year, the central bank’s researchers revised their inflation forecast upward to 3.2%, citing the more inflationary domestic environment than previously estimated, partly due to the prolonged intensity of the war into 2025.
“The factors liable to lead to an additional increase in the inflation environment are the continuation of the war and its impact on economic activity, including shekel depreciation,” said Yaron. “Should we see a faster acceleration in the inflation rate than our forecast, we could also raise the interest rate.”
Since the last interest rate decision at the end of August, the shekel has depreciated by 2.8% against the dollar. A weaker shekel makes imported goods more expensive, which in turn fuels prices of consumer goods.
