The Bank of Israel is facing a challenging decision regarding its short-term interest rates in light of rising price pressures and persisting geopolitical risks. Deputy governor Andrew Abir has expressed that it is unlikely for the central bank to lower interest rates at its remaining policy meetings in 2024. Despite holding the benchmark interest rate at 4.5% for the fifth consecutive decision, concerns over inflation climbing to 3.2% and the ongoing Gaza war have prompted caution in adjusting rates. This decision will largely depend on data-driven factors and the uncertainty surrounding the war and disruptions in key industries.
Analysts predict that Israel’s inflation rate may surpass 3.5% in the upcoming months, partly attributed to the planned increase in the value-added tax at the beginning of 2025. However, there is optimism that inflation will eventually ease back into the target range of 1%-3% in the second half of the year. Deputy governor Abir emphasizes the importance of observing progress in bringing inflation levels back down following the anticipated rise. He notes that much of the inflationary pressure stems from supply-side constraints, such as labor shortages linked to the exclusion of Palestinians, military conscription, and displacement of Israelis due to regional conflicts.
The extended duration of the conflict and its impact on the real economy have raised concerns about the potential consequences of interest rate adjustments. Abir warns that reducing rates at this time could exacerbate existing imbalances between demand and supply, leading to further price hikes, especially in the housing market. Despite modest economic growth of 1.2% in the second quarter, uncertainties surrounding the war and geopolitical risks have made investors cautious, seeking higher returns and contributing to currency volatility.
In addition to the monetary policy challenges, the geopolitical risks in the region, particularly the conflict with Hezbollah and Iran, have influenced Israel’s fiscal policy. The war has widened the budget deficit, prompting the need for a credible 2025 state budget that entails spending cuts and tax increases. However, the government’s delays in addressing these fiscal issues have left the central bank in a conservative stance regarding monetary policy decisions. Abir emphasizes the importance of fiscal stability in shaping the bank’s approach to interest rates amid ongoing uncertainties.
The Bank of Israel’s monetary policy faces complex challenges due to the interplay of rising inflation, geopolitical risks, and fiscal pressures. The decision to maintain interest rates amid the ongoing conflicts and economic disruptions reflects a cautious approach to safeguarding stability and managing risks in the Israeli economy. Moving forward, close monitoring of inflation trends, geopolitical developments, and fiscal reforms will be crucial in guiding the central bank’s policy decisions in a volatile and uncertain environment.