In surprising move, Bank of Israel reduces interest rates amid wartime economic challenges

In a surprising move, the Bank of Israel announced on Monday its decision to cut interest rates by 0.25%, marking the first reduction since the onset of the coronavirus crisis in March 2020. The rate now stands at 4.5%, following a series of 10 consecutive increases between April 2022 and May 2023, which elevated it from nearly zero to the previous level of 4.75%. Over the last six interest rate decisions, the bank had maintained a stable rate.

Simultaneously with the interest rate cut, the central bank revealed that the macroeconomic forecast for Israel's GDP remains unchanged. The GDP is anticipated to grow by 2% in both 2023 and 2024, with a significant uptick to 5% predicted for 2025.

However, the economic landscape is not without challenges, as the government deficit is expected to rise. According to the Bank of Israel, the deficit will reach 4% in 2023, an increase of 0.3% compared to previous estimates, and climb further to 5.7% in 2024, up from the previous forecast of 5%.

The central bank indicated that this interest rate reduction is the first of several expected in 2024, with the rate anticipated to range between 3.75% and 4.0% in the fourth quarter of the year.

Despite the easing of monetary policy, the Bank of Israel projects an inflation rate of 2.4% for 2024, unchanged from the November forecast. The moderation in inflation, according to the bank, is influenced by global and local economic developments and is further impacted by recent events such as the war, which has dampened consumer sentiment and demand.

The decision to lower interest rates was met with conflicting opinions among senior economists. Market estimates were divided, with some predicting a quarter-percent reduction due to a stronger shekel and decreasing inflation. Others believed the central bank would exercise caution and maintain the existing interest rate.

Market expectations were influenced by factors such as Israel's near-target inflation rate of 3.3% in November and the shekel's significant strengthening in recent months. Analysts also hoped for an interest rate cut to alleviate household debts, particularly amid the economic challenges posed by the ongoing war.

In November, the Bank of Israel had forecasted a reduction of at least 0.75% in the coming year. However, the capital market currently anticipates faster interest rate cuts, with rates potentially reaching 3.25% within a year.

Yoni Penning, Chief Transaction Strategist at Mizrahi Tefahot Bank, highlighted the relatively positive local economic picture despite the ongoing war. He noted stable to increased performance in private consumption, the current account, and government spending. Penning also acknowledged potential growth in construction activities, emphasizing the gradual improvement in the employment market and the strengthening shekel as factors supporting the central bank's decision to lower interest rates.

In conclusion, the Bank of Israel's unexpected move to reduce interest rates reflects its response to the complex economic landscape shaped by the war and other global and local factors. Analysts and market participants will be closely monitoring subsequent decisions and economic indicators for further insights into the central bank's strategy in navigating these challenging times.

This article originally appeared here and is reposted with permission.