Israeli interest rate cuts off table as war complicates next move

By Galit Altstein

Israel’s central bank is set to hold interest rates for a fourth consecutive time, a pause likely to stretch for several months amid fears that fighting against regional militant groups Hamas and Hezbollah could escalate.
 

Economists surveyed by Bloomberg are unanimous that the monetary committee will keep its benchmark at 4.5%, where it’s been since a quarter-point cut to start the year. Governor Amir Yaron will speak to reporters after the rate meeting.

Alongside its decision on Monday, the central bank will publish fresh economic forecasts and could revise an outlook from April that showed the key rate at 3.75% in the first quarter of 2025.

“We expect the Bank of Israel to err on the side of caution and not offer any more rate cuts this year,” said Barclays Plc economists including Zalina Alborova. “Even in a scenario of geopolitical improvement, inflation pressure is likely to prevent the bank from delivering a cut.”

With Israel’s war against Hamas now in its 10th month, risks are growing of an all-out conflict with Iran-backed Hezbollah in Lebanon. While talks on a cease-fire deal in Gaza have resumed, Prime Minister Benjamin Netanyahu’s government is preparing for the possibility of a full-on war with Hezbollah militants in Lebanon.

How the security crisis develops will matter for the central bank, whose assessment since the beginning of the war in October has been that the conflict’s economic impact will gradually decrease as the year unfolds. 

“If this assumption changes to a more severe scenario, that would probably wipe out the possibility of an interest rate cut,” said Ronen Menachem, chief markets economist at Bank Mizrahi Tefahot.

The turmoil is spilling over into markets, with the yield on the government’s 10-year shekel bonds reaching a 13-year high of 5.2% this month. The shekel is down close to 4% against the dollar since the start of March, one of the worst performers among a basket of 31 major currencies tracked by Bloomberg.

An escalation of hostilities across the northern border with Lebanon threatens further depreciation of the shekel, supply disruptions and a greater fiscal burden, all of which would intensify inflationary pressures. 

Government spending has already soared because of the war. Israel is on track to run one of its widest budget deficits this century with a shortfall the government estimates will reach 6.6% of gross domestic product in 2024.

 

Annual price growth is now at 2.8% — within the official target range but on track to exceed its 3% upper limit. Bank Hapoalim sees inflation at 3.3% over the next 12 months and Leader Capital Markets expects it at up to 3.4%, depending on the shekel’s value against the dollar. 

A longer wait for US interest rates to come down will likely delay the prospect of monetary easing in Israel, since a wider rate differential would threaten capital inflows and could undercut the local currency.

Federal Reserve officials at their last meeting dialed back their expectations for the number of cuts they see this year. The US central bank has held its key policy rate at the highest level in more than two decades since last July.

“These conditions do not allow for an interest rate reduction,” analysts at Bank Hapoalim’s financial division said in a report. “In a positive scenario assuming the cessation of hostilities, an interest rate cut will be back on the agenda toward the end of the year, but only after the US Fed commences loosening.”