(Bloomberg) -- Israel’s central bank left interest rates unchanged even as it lowered economic-growth forecasts, with the conflicts in Gaza and Lebanon causing inflationary pressures and preventing the country from joining a global easing cycle.
The bank kept its benchmark rate at 4.5% on Wednesday, in line with the estimates of all economists surveyed by Bloomberg. It was the monetary committee’s sixth straight hold.
Inflation accelerated to 3.6% year-on-year in August, above the 1%-3% target range, as government spending to fund the war effort surges and supply-side constraints worsen. At the same time, industries from tourism to agriculture and construction have slumped amid a slowdown in demand.
The central bank lowered its projection for growth this year to just 0.5% from 1.5%, and for next year to 3.8% from 4.2%.
“Supply restrictions in the labor market, mainly due to a shortage of non-Israeli workers and to those absent due to their serving in the reserves, continue to weigh on economic activity,” Governor Amir Yaron said. He called on the government to take steps to enable Palestinian workers — most of who have been barred from entering Israel from the West Bank since Hamas’ attack from Gaza last year — to return to the construction industry.
The Israeli shekel is down more than 3.5% against the dollar since the end of August, one of the weakest performances globally. And Israel’s risk premium, as measured by credit default swap contracts, is around its highest in 12 years.
Markets recently started pricing in the possibility of a rate hike, according to interest-rate swaps. Such a move would probably help the shekel, though Yaron said the bank was not considering that option yet.
“The current interest-rate level is sufficiently restrictive,” he said. “However, we are data dependent and if it rises more than expected we may definitely raise interest rates,” he added, referring to inflation.
The central announced an interest-rate forecast for the third quarter of 2025 of 4.5%, above its previous figure of 4.25% for the second quarter.
At a conference last week, Yaron said rate cuts are unlikely before the second half of 2025. On Wednesday, he made similar remarks, saying inflation would only slow back toward the target range in that timeframe. The central bank sees inflation ending this year at roughly 3.8%.
In the six weeks since the last rate decision, Israel’s multi-front conflict has intensified. It’s sent troops into Lebanon and faced a ballistic-missile attack from Iran, which Prime Minister Benjamin Netanyahu has vowed his government will retaliate against. He spoke to US President Joe Biden on Wednesday and was expected to outline Israel’s plan for Iran.
Fighting in Gaza, meanwhile, continues, with cease-fire talks between Israel and Hamas stalled.
Downgrades
Moody’s Ratings downgraded Israel by two notches to Baa1 late last month. S&P Global Ratings followed days later with a downgrade of its own. Both companies cited the government’s high spending to finance the war effort.
The cost of a prolonged conflict in Lebanon or with Iran will put even more pressure on the government’s stretched finances. The 2024 budget will be probably be revised for a third time before the year is out and may include a larger projected deficit than the original one, which was 6.6% of gross domestic product.
The central bank now predicts a fiscal deficit of 7.2% for this year, which would be Israel’s biggest this century excluding the Covid-19 pandemic in 2020. The bank says the figure will drop to 4.9% in 2025, assuming the government makes spending cuts and tax rises totaling around 30 billion shekels ($8 billion).
Even if it does, that’s still higher than the government’s own declared target deficit of 4% for next year.
Netanyahu’s cabinet is expected to approve the 2025 budget at the end October. It will then be put to parliament, where it needs to be approved by the end of March to avoid a collapse of the government.
Some taxation measures designed to increase revenues by around 13 billion shekels have been outlined. But there’s no guarantee Netanyahu’s far-right coalition members will agree to make the bigger adjustments called for by the central bank.
For some analysts, the economy is too weak to absorb rate hikes, even if inflation is accelerating.
Tighter monetary policy “won’t influence inflation and will have a moderate effect, if any, on the shekel,” Shmuel Katzavian, a strategist at Israel’s Discount Bank, said in a note published shortly before the central bank’s decision. “Such a move will have considerable negative consequences.”
(Updates with more detail and comments.)
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