(Bloomberg) -- Israel’s central bank is set to hold interest rates for a fifth straight meeting, in an effort to balance a weakening economy against inflationary pressures as war spending surges.
Analysts surveyed by Bloomberg are unanimous in forecasting that the Bank of Israel will hold its key rate at 4.5% on Wednesday. An announcement is scheduled at 4 p.m. local time.
While major central banks such as those of the US, euro zone and UK are either starting to cut rates or expected to do so soon, Israel is having to put off easing. After starting the year with a rate cut, the Bank of Israel has had to shift gears and focus on the growing financial and economic fallout of the war against Hamas in Gaza and tensions with other Iran-backed militant groups such as Hezbollah.
“The Bank of Israel will continue to err on the side of caution near term, especially as the geopolitical environment remains tense,” Anatoliy Shal, an analyst at JPMorgan Chase & Co., said in a recent note. He expects a first cut, of 25 basis points, will come in November, followed by another 50 basis points of easing by the middle of 2025.
Still, the central bank may, he said, be forced into “a more delayed and shallower” easing cycle if hostilities don’t end.
Gross domestic product grew by 2% last year, almost half the rate the finance ministry expected prior to the outbreak of the war, and JPMorgan sees an expansion of just 1.4% in 2024, having cut its forecast twice in recent weeks.
The war in Gaza has been raging for almost 11 months and — though cease-fire talks are ongoing — there’s little sign it will end soon. Moreover, there’s a risk of a full-blown conflict with Hezbollah, an even more powerful group than Hamas.
Fitch Ratings said the war in Gaza “could last well into 2025” when it downgraded Israel’s rating to A this month.
Annual inflation rate has risen from 2.5% in February to 3.2%, above the country’s official target of 1% to 3%.
Alex Zabezhinsky, chief economist at Meitav DS Investments Ltd., doubts it will fall into that range again over the next year.
“The continuation of war increases inflation and distinguishes the local economy from a growing global trend of decreasing price levels,” Zabezhinsky said.
The labor market is tight, with unemployment at just 2.8%. That is partly a result of shortages caused by large numbers of employees being called up to the military or being displaced, mainly from Israel’s northern region. Restrictions on Palestinians going into Israel from the West Bank and Gaza exacerbate the problem. Before the war, such workers were a mainstay of Israeli construction sites.
“Demand for workers is high, which brings on wage pressures,” says Leader Capital Markets’ economic strategist, Jonathan Katz.
The shekel, meanwhile, has appreciated in the past three weeks, but would likely struggle if the central bank opted to ease rates anytime soon, according to traders.
Another concern for the central bank is the government’s fiscal policy. The budget deficit rose to 8.1% of GDP in the 12 months through July.
Delayed Budget
Prime Minister Benjamin Netanyahu and Finance Minister Bezalel Smotrich have delayed discussions on the 2025 budget, set to be the most challenging in decades, despite the process usually being well underway by this time of year.
Central bank Governor Amir Yaron has for weeks been calling for budgetary cuts totaling some 30 billion shekels ($8 billion) to balance increased defense expenditure and steady Israel’s debt levels. The country’s ratio of debt to GDP will climb to 67.5% this year, up from around 59% in 2022, according to the central bank.
Although Netanyahu insists there will be a fiscal framework in place before the start of 2025, the delay is making markets and technocrats at the finance ministry wary.
A rise in the spread of shekel bond yields over US Treasuries to an 11-year high is a result of investor concerns “over fiscal credibility and the government’s procrastinating in presenting a budget for 2025,” said analysts at Bank Hapoalim, one of Israel’s two largest lenders.
“Credit rating agencies are focused on the security situation, but without a credible budget that will signal a sustained debt-to-GDP ratio, the chances of further rating downgrades are high,” they said.
--With assistance from Paul Abelsky.
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