Despite a lower-than-expected inflation reading in Israel, many analysts argue that the central bank will not resume its rate cutting cycle anytime soon. The ongoing war against Hamas is seen as a significant constraint for policy makers. May’s inflation rate of 2.8% was below a consensus of 3.2%, surprising markets. However, the inflation rate is still within the target range of 1%-3% annually. The global context also plays a role, with many central banks already easing policy.
The war with Hamas, now in its ninth month, and tensions on the northern border with Hezbollah continue to pose significant risks for Israel. The entire monetary consideration at the moment appears to be overshadowed by elevated geopolitical risks. The ongoing conflict has kept Israel’s risk premium high, prompting the Bank of Israel to maintain a cautious stance. Despite the stable dollar-shekel exchange rate, spreads between Israel dollar-denominated bonds and U.S. government bonds have widened.
The Bank of Israel lowered its benchmark interest rate in January following a series of aggressive rate increases. The next policy decisions are scheduled for July and August. While inflation remains sticky and geopolitical risks persist, some analysts have revised their expectations regarding rate cuts. JPMorgan has scaled back its projections, while Goldman Sachs anticipates cuts in the third and fourth quarters. However, the timing of these cuts remains uncertain due to the current level of unpredictability.
While some analysts predict rate cuts in the near future, others are more cautious. It is expected that the Bank of Israel may err on the side of caution and refrain from offering more rate cuts this year. Mizrahi Tefahot chief strategist Yonie Fanning noted that markets have already priced in rate cuts over the next year, despite the recent inflation reading. BOI Governor Amir Yaron emphasized that rates cannot decline as long as inflation pressures persist and the war against Hamas remains uncertain, leading to increased government spending.
One of the key challenges for investors, as well as the central bank and economists, is the unpredictability associated with the Consumer Price Index (CPI). The April index was higher than expected due to volatile international airfares, while the May index was influenced by a significant drop in the same item. This fluctuation in the CPI is seen as ‘noise’ around flight prices. Additionally, factors such as higher wages and an expansion of the government’s budget deficit contribute to price pressures in the economy.
The current economic environment in Israel is marked by a delicate balance between inflationary pressures, geopolitical risks, and uncertainties surrounding monetary policy. The ongoing conflict with Hamas and heightened tensions in the region continue to pose significant challenges for policy makers. While some analysts anticipate rate cuts in the near future, others remain cautious. The unpredictability of the CPI adds another layer of complexity to the economic outlook. As Israel navigates these challenges, it will be crucial for the central bank to carefully consider its monetary policy decisions in the coming months.