Central bank sees economy improving but warns of continued geopolitical uncertainty
Bank of Israel holds interest rates at 4.5%, citing rising inflation following January tax hikes, including VAT; governor warns lawmakers against making changes to the 2025 budget
Sharon Wrobel is a tech reporter for The Times of Israel.
The Bank of Israel on Monday raised its growth prospects for the economy for this year as it expects the intensity of fighting to moderate in the coming months, but cautioned that the forecast is overshadowed by continued geopolitical uncertainty and expectations for increased inflation.
“The state of the Israeli economy is improving,” Bank of Israel governor Amir Yaron said at a press conference in Jerusalem. “However, the effect of the war, the uncertainty and the various challenges are still with us.”
The central bank revised its growth forecast and now expects the economy to have grown by 0.6 percent in 2024, 4% in 2025 and 4.5% in 2026, assuming that the “direct economic impact of the war will continue until the end of the first quarter of 2025.” That forecast was moderately improved from a previous growth projection in October of 0.5% in 2024 and 3.8% in 2025.
“The economy’s risk premium has declined [but] remains high compared to its prewar level,” said Yaron. “This is, among other things, against the background of geopolitical developments, the ceasefire in the north, the declining intensity of the fighting, approval of the budget by the government and of the package of taxation measures by the Knesset, which have led to the markets’ improved confidence in the Israeli economy.”
“Therefore, it is important that the budget framework for 2025 will be approved without additional changes, which will contribute to maintaining the markets’ trust,” Yaron emphasized.
Meanwhile, the governor reiterated the central bank’s criticism of the 2025 budget composition and the government’s failure to slash coalition funds, and enact the closure of unnecessary government ministries to free up crucial sources of financing to fund ballooning war costs.
“It would have been better to integrate more growth-supporting components for the long and short terms, with an emphasis on removing barriers, and in particular to reduce expenditures that create negative incentives to entering the labor market and to increasing productivity,” Yaron lamented.
“In addition, at a time when the public has to bear the burden of painful steps, it would have been proper for the government to reduce the number of ministries and to make a substantial contraction in coalition funds that do not support growth.”
Back in October, the central bank lowered its growth outlook for 2024 and 2025 as the year-long war with the Hamas terror group and intensified fighting with Hezbollah in the north continued to take a heavy toll on the country’s finances. Since then, a truce agreement was signed by Israel and the terror group on November 27, and the Israeli army is required to cede all of its positions in southern Lebanon to the Lebanese army within 60 days.
Alongside the revised growth forecasts, the central bank decided to hold the benchmark interest rate at 4.5% for an eighth consecutive meeting, citing the need to “deal with the continued geopolitical and economic uncertainty” and expectations for increased inflation. The rate decision was in line with forecasts by most economists who have started to price in the possibility of an interest rate cut in the coming months.
“The inflation rate is expected to continue to rise in the first half of the year, among other things against the background of the tax increases, and is expected to moderate in the second half of 2025,” said Yaron.
On January 1, a series of tax increases, price hikes and utility cost hikes came into effect. Among the measures, is an increase in the value-added tax in Israel from 17% to 18%. As a result, the central bank expects the annual inflation rate to accelerate during the first quarter of the year to about 4% and ease to 2.6% by the end of 2025.
Annual inflation in November eased to 3.4%, down from 3.5% in October, but it is still above the government’s target range of 1% to 3%.
Asked what steps the Bank of Israel is taking to ease the economic and financial burden of Israeli households and businesses as the financial blows came into effect earlier this month, Yaron responded that the “interest rate tool is the right tool to deal with rising inflation that hurts the weaker sections,” of the population.
“Lowering the interest rate right now is like trying to take out a fire with fuel,” said Yaron. “Lowering rates will increase demand without increasing supply, which will lead to price rises also because of labor shortages.”
The Bank of Israel’s research department projects that borrowing costs will fall to 4.25% or 4% by the end of 2025 as inflation eases to its target range.
“The good news is the interest rate is expected to drop by 25 basis points to 50 basis points in the last quarter of the year,” said Ronen Menachem, chief markets economist at Mizrahi Tefahot Bank. “Meanwhile, the Bank of Israel still recognizes the need to stabilize the markets and reduce uncertainty.”
The last time the central bank cut interest rates was in January 2024, when it lowered borrowing costs for the first time in almost four years by 25 basis points, from 4.75%, to support households and businesses in the early months of the Hamas war, and as the inflation environment was easing.
