Central bank holds borrowing costs steady, despite subdued growth, jumping inflation
Bank of Israel keeps interest rates steady at 4.5% citing geopolitical uncertainty, shekel volatility, and fiscal changes
Sharon Wrobel is a tech reporter for The Times of Israel
The Bank of Israel on Monday opted to leave borrowing costs unchanged at 4.5 percent, though inflation accelerated last month, and despite warning that growth is slow, as war-related costs and government spending on defense continue to weigh on the economy.
“The recovery in economic activity continues at a moderate pace, in view of geopolitical developments…the annual inflation rate increased, partly due to tax increases, and is above the upper bound of the target range [of 1% to 3%],” the central bank said. “In view of the continuing war, the monetary committee’s policy is focusing on stabilizing the markets and reducing uncertainty, alongside price stability and supporting economic activity.”
“The interest rate path will be determined in accordance with the convergence of inflation to its target,” the central bank added.
Annual inflation accelerated to 3.8% in January from 3.2% in December, after a series of government tax hikes came into effect last month, including an increase in VAT from 17% to 18%, to help fund war expenditures, according to data by the Central Bureau of Statistics. The Bank of Israel expects inflation to converge into the government’s annual target range of 1% and 3% in the second half of the year.
At the same time, the central bank’s monetary committee, headed by Governor Prof. Amir Yaron, cautioned that “geopolitical developments and their impact on economic activity, prolonged supply constraints, volatility of the shekel, and fiscal developments,” pose risks to inflation pressure moderating.
Ahead of the interest rate decision, economists were in consensus that the central bank would not rush to lower the base lending rate, but projected that borrowing costs for mortgage and loan holders could start coming down over the course of the year with the first one expected as early as in May.
The central bank last lowered interest rates in January 2024, which marked the first cut in almost four years, in an effort to support households and businesses as the economy was getting battered by the war with the Hamas terror group and as the inflation environment was easing. Since then, borrowing costs have remained steady.
“As far as the Bank of Israel is concerned, slow growth (and current consumption) in the fourth quarter should support a reduction in the interest rate in the future, but the Bank of Israel prefers to wait and examine the data for the first quarter, including the inflation environment,” said Leader Capital Markets macroeconomist Jonathan Katz. “The governor is concerned about wage pressure and inflation from the demand side and prefers to postpone monetary loosening.”
The economy expanded at a slower pace in the October-to-December quarter, but it still grew by 1% in 2024, surpassing forecasts, as the war with Hamas and fighting with Iran-backed Hezbollah increased government spending on military and civilian needs and took a toll on the country’s exports and investments.
The central bank emphasized that home prices continued to rise, as the construction industry was still affected by labor shortages, but noted that the difference between the number of people currently employed in the industry and the number before the war has narrowed.
The Manufacturers’ Association of Israel urged the government to take the necessary steps to increase the supply of workers in the economy, including the removal of barriers for the entry of foreign workers.
“One of main reasons the Bank of Israel has difficulty in lowering interest rates stems from supply constraints in the economy, caused mainly by a lack of workers,” said Manufacturers’ Association of Israel president Ron Tomer. “As a result of the shortage, wage pressures are created that lead to price increases fueling inflation pressure, while borrowing costs remain high, which burdens businesses as they continue to pay high interest on loans.”
“In addition, rising mortgage repayments reduce the disposable income of households,” Tomer remarked.
Assuming that inflation will show signs of moderation in the coming months, Katz expects that the central bank will start lowering interest rates by 25 basis points to 4.25% at its monetary policy meeting on May 26, and projects another two cuts in August and November, pushing borrowing costs down to 3.75% at the end of the year.
