Israel’s central bank pauses rate cuts, amid ongoing uncertainty over war’s impact
Bank of Israel holds borrowing costs steady at 4.5% and expects the pace of interest rate cuts this year to be gradual and cautious
Sharon Wrobel is a tech reporter for The Times of Israel.
The Bank of Israel on Monday opted to take a breather and leave borrowing costs unchanged after last month’s bold rate cut, citing great uncertainty over the extent of the impact of the ongoing war with Hamas in Gaza.
“Beyond security issues, the war brings with it marked economic ramifications as well (…), and the uncertainty remains high,” said Bank of Israel governor Amir Yaron. “However, the economy’s robustness and the rapid recovery it has displayed in recent months have also been reflected in financial markets’ recovery and stability.”
The central bank decided to hold interest rates at 4.5 percent. Ahead of the decision, economists were not split on whether interest rates would come down further, but over the timing of the move, with some expecting another reduction at the next meeting in April, given uncertainty over the progress of the war and the risk of an escalation of fighting on the northern front with Hezbollah.
Monday’s call came after the Bank of Israel on January 1 cut the base lending rate, for the first time in almost four years, by 25 basis points from 4.75% to 4.5% to support households and businesses as the economy was getting battered, due to the Hamas war, and as the inflation environment was easing.
Yaron noted Monday that the path of interest rate cuts so far is consistent with the outline presented by the central bank’s research department last month, according to which borrowing costs are expected to come down to a range of 3.75% to 4% by the end of the year.
“Interest rate reductions will be measured and cautious in light of the great uncertainty that persists in the economy, mainly against the background of the progress of the war, and the economy’s risk premium [that] is still at a high level, despite some decline in recent weeks,” said Yaron.
Bank Hapoalim chief strategist Modi Shafrir said that financial markets continue to price in a slightly sharper interest rate cut path to a level of about 3.5% by the end of the year.
Israel’s economy shrank an annual 19.4% in the last three months of 2023 from the previous quarter as the aftermath of the Hamas October 7 onslaught took a heavy toll on consumer spending, trade and investment.
Israel called up hundreds of thousands of reservists to join the fighting and evacuated large swaths of the Gaza and Lebanon border, with businesses closing and people staying home under a rain of rockets, as the country shifted to a war footing. Sectors that rely on foreign labor forces, such as construction and agriculture, were especially hard hit.
For the full year of 2023, Israel’s economy expanded by 2%, after growing at a fast pace of 6.5% in 2022. The annual GDP figure was in line with forecasts by the Bank of Israel and above the average growth rate of 1.7% among OECD countries.
Local economists at Bank Hapoalim, Bank Leumi, and Israel Discount Bank had predicted Monday’s central bank decision. Some global investment banks, including Goldman Sachs, had expected the central bank to cut interest rates by a quarter percentage point, to 4.25%, as inflation has been easing into the government’s target range of 1% to 3% in recent months. That’s after the Bank of Israel steadily hiked interest rates from a record low of 0.1% in April 2022 to 4.75% in July 2023, to bring inflation down.
Yaron remarked that while the economy was “notably adversely impacted in the final quarter of 2023,” due to the war, it is “showing signs of recovery in several notable indicators,” including the labor market and credit card activity.”
“Credit card purchases, which declined markedly in the first weeks of the war, are recovering and their overall level is higher than the average prewar level during the course of 2023,” Yaron said.
Yaron pointed to a number of risks, including increased war-related government spending, that could impact the downward trend in the inflation rate which has moderated to a level of 2.6%.
“The expansionary fiscal policy and its effects, and the limitations on activity in the construction area, still present a risk to the continued moderation of inflation,” said Yaron. “The security situation led to a negative impact on activity in the construction industry, primarily due to a lack of workers.”
“Actions should be taken to keep the supply of construction high over time,” he urged.
With the outbreak of the war, Palestinian workers, upon which the construction industry relies, disappeared overnight, as Israel enacted an immediate ban on workers from Gaza and restricted access to most of those from the West Bank. Thousands of foreign workers from China, Thailand, the Philippines, and other countries also went home following the shock attack, as the economy ground to a halt. In recent weeks, some building sites are getting back to work.
