(Bloomberg) -- Israel’s central bank left interest rates unchanged as it weighs a war-related economic slowdown and quickening inflation.
The Bank of Israel held its base case rate at 4.5% on Monday, in line with the estimates of all economists surveyed by Bloomberg. It was the monetary policy committee’s seventh straight hold and last decision of the year, with the next meeting scheduled for early January.
Governor Amir Yaron has said inflationary pressures brought on by the ongoing conflicts against Hamas and Hezbollah will likely keep rate cuts off the table until the second half of 2025. Israel’s annual inflation stood at 3.5% as of October, above the government’s target range of 1% to 3%, largely due to supply-side constraints.
The Bank of Israel’s monetary committee said in a statement accompanying the rate decision that, according to forecasters’ projections, inflation will continue to increase at the start of 2025 — when Value Added Tax is set to increase — and is then expected to moderate toward the upper bound of the target range in the second half of the year.
“In the Committee’s assessment, there are several risks of a possible acceleration of inflation: geopolitical developments and their impact on economic activity, prolonged supply limitations, volatility of the shekel, and fiscal developments,” said the committee.
On the political side, Israeli and US officials have said talks on a cease-fire with Lebanon-based Hezbollah have made progress in the past week. Israel’s security cabinet led by Prime Minister Benjamin Netanyahu will meet on Tuesday and may vote on an agreement, according to an Israeli official familiar with the matter, though it’s unclear if Hezbollah will accept a deal.
“The continuing geopolitical uncertainty continues to pose difficulties for economic activity and is delaying the economy’s return to the level of activity that characterized it prior to the war,” the Bank of Israel said.
The shekel strengthened on reports that a Lebanon cease-fire is near, gaining 1.8% against the US dollar, the best performer in a basket of expanded currencies tracked by Bloomberg. A stronger shekel could further support a policy of holding rather than raising rates.
Construction, Farming
Above-target inflation has been driven in part by the construction and agriculture sectors, which have been hit by a shortage of Palestinian workers who are banned from entering Israel, causing rent and food prices to rise significantly over the past year.
Israel’s aviation market has also suffered with many international carriers avoiding the country, sending airfare costs soaring.
Inflation may accelerate to as much as 4% after the planned VAT increase in January and probably won’t fall back into the bank’s target range before the end of 2025, according to Yoni Fanning, a strategist in Tel Aviv at Mizrahi Tefahot Bank.
At the same time, the central bank sees the economy growing just 0.5% this year, down from its earlier projection of 1.5%.
The Bank of Israel noted the approval of the 2025 budget at the start of this month with a planned deficit of 4.4% of gross domestic product, saying it includes fiscal adjustments totaling about 35 billion shekels ($9.6 billion) in accordance with the central bank’s recommendations.
“The government’s approval of the budget is a significant step, but it is important to maintain the framework that was approved by the government through the remaining legislative process,” the bank said.
(Updates with central bank comments starting on fourth paragraph; cease-fire latest from sixth.)
