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Israel delivers first interest rate cut since pandemic as war rages

The monetary committee on Monday lowered its key rate to 4.5% from 4.75%, ending a pause in place since July

Israel
Photo: Bloomberg
Bloomberg
4 min read Last Updated : Jan 01 2024 | 10:39 PM IST
By Galit Altstein


Israel’s central bank cut interest rates for the first time since the height of the global pandemic in 2020, in a sign it’s more confident that markets have stabilized almost three months into the war against Hamas.
 
The monetary committee on Monday lowered its key rate to 4.5% from 4.75%, ending a pause in place since July. A narrow majority of economists polled by Bloomberg predicted the move, and markets are betting rates will fall below 3.4% by the end of 2024.

The shekel pared gains after the announcement, trading 0.2% stronger against the dollar.

In a statement accompanying the decision, policymakers largely repeated their guidance from November, saying the focus is on “stabilizing the markets and reducing uncertainty, alongside price stability and supporting economic activity.” The central bank gave no clear signal about the timing of what it plans to do next.

“The interest rate path will be determined in accordance with developments in the war and the uncertainty derived from it,” it said. “Insofar as the recent stability in the financial markets becomes entrenched and the inflation environment continues to moderate toward the target range, monetary policy will be able to focus more on supporting economic activity.”

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The decision signals priorities are starting to shift in favor of supporting the economy, after an effort by policymakers led by Governor Amir Yaron to steady markets following the attack by Hamas on Oct. 7. The focus has changed with a slowdown in inflation and as local assets recouped their losses while the shekel staged the world’s biggest rally versus the dollar in the past two months, gaining over 12%.




The rate reduction put the Bank of Israel well ahead of the expected start of monetary easing by the US Federal Reserve, which it largely followed during a record tightening cycle that’s brought local rates to their highest since 2006.

The case had been building for Israel to deliver some monetary stimulus as inflation converged on the 1%-3% goal for the first time since 2021 and the economy at risk of a contraction. The central bank said on Monday it expects inflation will enter the target range in the first quarter of the year.

Economists at Goldman Sachs Group Inc., who changed their call to a cut from a hold before the decision, pointed to “receding financial stability risks and the recent relatively benign inflation prints” as warranting a more dovish approach.

“The initial inflation prints since the start of the conflict have been relatively weak,” Goldman analysts led by Kevin Daly said in a report. “Inflation is now likely to fall back in to the Bank of Israel’s target in the coming quarter, with the appreciation of the shekel also limiting upside inflationary risks.”

War, Budget
 
Risks abound, however, as the central bank weighs the implications of fiscal plans related to the Hamas war, which could saddle the country with a bigger debt load. 

On Monday, an updated outlook from the central bank’s research department showed the government’s budget deficit was at an estimated 4% of gross domestic product in 2023 and is set to reach 5.7% this year — higher than its assessments in November.

The Bank of Israel’s forecasters also predict the debt-to-GDP ratio at about 66% in 2024-2025 before the burden starts declining in the subsequent years to reach about 63% in 2030.

Differences with the government may prove critical to what happens next, with Yaron earlier calling for “a responsible fiscal framework” as officials reshape the budget during wartime. 

A Finance Ministry report published in December cited a 75 billion-shekel ($21 billion) war bill that will need to be funded with borrowing or budget cuts, combined with higher taxation. The government has so far indicated it’s not willing to take steps that the central bank will likely consider sufficient to keep debt in check.

The risk that the war against Hamas could expand into a wider conflict is another reason for future caution. Disruption persists across the economy with the deployment of hundreds of thousands of troops, and whole communities evacuated from their homes along Israel’s southern and northern borders. 

Some parts of the market still remain on edge, with the cost to insure Israel’s sovereign bonds against a default far above its level before the war began.

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Topics :israelInterest RatesGlobal economyeconomyfinance sector

First Published: Jan 01 2024 | 9:12 PM IST

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