Recently, Deputy Governor Andrew Abir of the Bank of Israel made a statement indicating that the central bank is unlikely to lower short-term interest rates at its upcoming policy meetings. This decision comes in light of rising price pressures and persisting geopolitical risk. The Bank of Israel had previously held its benchmark interest rate at 4.5% for the fifth consecutive time due to concerns over inflation, which had risen to a rate of 3.2%. It seems that the central bank is taking a cautious approach to monetary policy amid uncertainties related to the ongoing Gaza war and fears of potential regional conflicts.
Abir mentioned that the decision to keep interest rates steady until at least 2025 is data-dependent. He emphasized that the current uncertainties surrounding the war and disruptions in key industries make it challenging for the central bank to consider rate cuts. Israel’s inflation rate is projected to exceed 3.5% in the coming months, partly driven by an anticipated increase in the value-added tax at the beginning of 2025. However, there is an expectation that inflation will eventually return to the central bank’s target range of 1%-3% in the second half of the year. Abir stressed the importance of observing progress in bringing down inflation to within the target range before contemplating any rate adjustments.
Abir pointed out that much of the inflationary pressures are stemming from the supply side of the economy. Factors such as a shortage of workers, restrictions on Palestinian labor, military service call-ups, and population displacements due to regional conflicts are contributing to the inflationary environment. The prolonged duration of the war has resulted in significant disruptions to key sectors like construction, leading to a decline in investments. Lowering interest rates at this juncture could potentially exacerbate the imbalance between supply and demand, further fueling price increases, especially in housing costs.
Global and Fiscal Influences
Amidst uncertainties and geopolitical risks, investors are seeking higher returns, making it challenging for the central bank to consider rate cuts. Abir highlighted that reducing interest rates could lead to a widening gap between demand and supply, triggering inflationary pressures. Additionally, the ongoing conflict and its financial implications have widened the budget deficit, putting pressure on fiscal policy. The inability of the government to commit to a credible 2025 state budget has further added to the central bank’s caution and conservative approach towards monetary policy decisions.
The Bank of Israel’s reluctance to lower interest rates underscores the complex interplay of factors influencing monetary policy. The central bank’s focus on maintaining stability amidst rising inflation and geopolitical risks reflects a strategic approach to safeguarding the economy. As uncertainties persist, it is crucial for policymakers to strike a balance between supporting economic growth and addressing inflationary pressures through prudent monetary measures.