Deputy Governor Andrew Abir recently stated that the Bank of Israel is facing challenges in lowering short-term interest rates due to rising price pressures and persisting geopolitical risk. The decision to hold the benchmark interest rate at 4.5% for the fifth consecutive time was influenced by concerns over inflation, which has risen to a rate of 3.2%. Additionally, the ongoing Gaza war has raised fears of a potential regional conflict, further complicating the central bank’s policy decisions. While a 25 basis point easing was implemented in January, the bank has since maintained steady rates, with Abir indicating that a rate cut is unlikely until well into 2025.
The central bank’s reluctance to lower interest rates is attributed to the uncertainty surrounding the economy, particularly the impact of the prolonged war and disruptions in key industries. The lack of progress on resolving the conflict and the resulting dislocation of workers have led to inflationary pressures, with the inflation rate expected to surpass 3.5% in the coming months. Abir emphasized the need for inflation to return to the target range of 1%-3%, highlighting the challenges posed by the current economic environment.
Abir pointed out that much of the inflationary pressure is originating from the supply side of the economy, with factors such as a shortage of workers exacerbating the situation. Restrictions on Palestinian workers entering Israel, military call-ups, and displacement of Israelis in the north due to ongoing conflicts have all contributed to the supply constraints. The prolonged war has also disrupted investments, particularly in the construction sector, further straining the economy.
While lowering interest rates could potentially stimulate economic growth, Abir warned against the negative consequences of such a move in the current environment. Lowering rates could widen the gap between demand and supply, resulting in further price increases, especially in housing costs. Despite modest economic growth of 1.2% in the second quarter, the central bank is cautious about implementing rate cuts that could exacerbate inflationary pressures and depreciation of the currency.
External factors, such as the Federal Reserve’s anticipated rate cuts and geopolitical tensions, have also influenced the Bank of Israel’s monetary policy decisions. The volatility of the shekel reflects investors’ concerns over the geopolitical risks in the region. Additionally, the war has contributed to a rise in the budget deficit, prompting the central bank to urge the government to take decisive action in implementing a credible 2025 state budget. Fiscal challenges have further constrained the bank’s ability to pursue aggressive monetary policy measures.
The Bank of Israel faces a complex set of challenges in navigating the current economic landscape. Balancing the need to manage rising inflation, geopolitical risks, and supply-side constraints while ensuring sustainable economic growth requires a cautious and data-dependent approach to monetary policy. The central bank’s decision to maintain interest rates reflects a cautious stance aimed at preserving economic stability amidst a challenging environment.