The Bank of Israel left the interest rate unchanged, at a level of 4.5% for the fourth time in a row according to estimates. According to the senior economists, the high risk premium in Israel together with the devaluation of the shekel and the security uncertainty, led the bank to leave the interest rate unchanged.
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At the same time, the bank published growth forecasts for 1.5% in 2024, a decrease of 0.5% from the previous forecast. For 2025, the forecast was updated downwards to 4.2% from 5%. Alongside this, the bank predicts that annual inflation will reach 3% by the end of 2024, compared to 2.8% in the previous forecast. In the next 12 months, the bank expects that inflation will cross the upper limit of the price stability target and stand at 3.2%.
As far as future interest rate forecasts are concerned, in the coming year the bank expects one interest rate reduction, in contrast to the previous forecast, when it expected three interest rate increases in the coming year.
“Political uncertainty increases in light of the war”
In his speech at the opening of the press conference, Bank Governor Prof. Amir Yaron said following the decision to leave the interest rate unchanged that: “Political uncertainty is increasing in light of the war, the economy’s risk premium has increased, but at the macro level the economy continues to show resilience in the face of challenges.”
“The war has significant consequences, despite the improvement, there is still a long way to go before a return to normalcy. The bank continues to work with the aim of overcoming the period of accumulation. We have taken several steps in order to help the affected populations.
Following the increase in unemployment, the committee focused on stabilizing the markets and supporting economic activity. The interest rate path will continue to be determined according to the stability of the markets, the moderation of inflation and the fiscal policy.
“We continue to pursue a monetary policy that supports the recession of inflation”
The governor also added that: “Inflation in Israel is indeed within the target range, but continues to be at the upper limit of the range, while there was a certain increase in the inflation environment in the quarter
the last one. It must be remembered that inflation is a process that harms the economy and growth, and makes it difficult for economic conduct in the economy as a whole and mainly harms the weaker populations. Therefore, we continue to adopt a monetary policy that supports the recession of inflation.
“Indices excluding taxation, energy and fruits and vegetables continue to remain in the vicinity of the center of the target. However, the expectations for inflation for the various ranges – which are an important component of the analysis we conduct to examine the monetary process – are at the upper limit of the target, and in some cases even above it in the coming months. I will remind you that the expectations also embody the increases The expected taxes. The committee estimates that among the factors that may lead to an increase in the inflation environment are: the continuation of the war and its effect on the activity in the economy, including the devaluation of the shekel, the activity in the housing market and its limitations, the fiscal developments and oil prices in the world.”
The governor also added that the analysis of the real activity in the economy shows that: “The overall level of activity in the economy is still lower than that which prevailed on the eve of the war. Since the last interest rate decision, the recovery in economic activity recorded in the first quarter of the year has been delayed. According
The current indicators, the moderation of the growth rate of economic activity in the second quarter, and the supply limitations make it difficult for economic activity to converge to the trend that prevailed before the war. The growth rate of private consumption, which recovered in the first quarter of 2024, also decreased slightly during the second quarter, as reflected in the credit card spending data.
“At the same time, we see an encouraging improvement in the amount of capital raised by the start-up companies in the second quarter, which is a significant indicator given the importance of the high-tech industry to the Israeli economy. We are closely monitoring the developments in the housing market. In recent months, there has been a significant increase in apartment prices, following the decreases recorded in 2023. In May, the volume of mortgages increased compared to the previous months and stood at NIS 7.8 billion.
The construction industry is still not operating at its full potential
“At the same time as the increase in demand, the construction industry is still not operating at its full potential and is mainly affected by the lack of workers; the return of construction sites to full activity is progressing at a slow pace. Since the main barrier on the supply side is the limitation of manpower, it is important to continue promoting the process of bringing foreign workers from different countries to the construction industry In addition, subject to the security guidelines, maximum exploitation of the Palestinian workers’ potential in the industry must be considered. In addition to maintaining the activity in the immediate term, the necessary actions must be taken to maintain a high construction supply over time. This is the key to moderating housing prices.
“The magnitude of the adjustments required in the next budget is significant”
Regarding the budget, the Governor of the Bank of Israel elaborated: “I want to emphasize, the order of magnitude of the adjustments required in the next budget is significant, therefore the early start of the process at the Ministry of Finance is positive, and as the security requirements increase, we will have to make adjustments accordingly.
Only partial compliance by the fiscal states or the postponement of the budget into 2025, will already lead to an increase in Israel’s risk premium, this along with the consolidation of the markets’ perception that Israel’s GDP debt ratio is improving.
As part of the press conference, on behalf of Globes, the Governor was asked how he reflects to investors around the world the situation in Israel in light of the macroeconomic data that are affected by the war, alongside the high CDS premium and the credit yield spreads between Israel and the US: “When I travel around the world, I invest a lot of input regarding budget adjustments that we are making in Israel and refines the major adjustments that we will also make in the 2025 budget as long as the war continues. At the same time, I remind you that the economy in Israel is still growing and high-tech recruitment is still rising.”
The dilemma of the Bank of Israel
When looking at the inflation environment in Israel, it is hard not to notice the complexity of the central bank’s decision. On the face of it, the May index surprised early expectations when the annual inflation rate in Israel converged to a level of 2.8% and core inflation was set at 2.2%. These levels actually support the continuation of the Bank of Israel’s interest rate reduction plan, which was stopped following the only interest rate reduction that took place at the beginning of January this year.
At the same time, it seems that the central banks around the world are starting to lower interest rates one by one, when the inflation levels in the global economies are converging towards the price stability goal of the central banks. There is no doubt that the central bank takes into account the disadvantage of opening interest rates between Israel and the rest of the world.
However, the high risk premium indicates that Israel’s situation is getting worse. Modi Shafferer, Chief Financial Markets Strategist at Bank Hapoalim, noted that Israel’s risk premium is reflected in the dollar bond spread once morest the American equivalent, which is 1.7%. -, which is evidence of the increase in our risk premium in the world.” Israel is currently more similar to the BBB- rating than the official rating, still in the A countries.
In the current geopolitical situation, alongside the high risk premiums and the sharp devaluation of the shekel, it seems that the central bank has no choice but to take a more cautious approach in managing the level of interest in the economy and wait for some certainty, even a tiny one, regarding security developments.
“The risks to the inflation forecast are biased upwards”
Matan Shetrit, the Phoenix Group’s chief economist, refers to the decision and explains: “As expected, the Bank of Israel left the interest rate unchanged due to the ongoing geopolitical uncertainty, as recently there was another increase in the risk premium indices as shown by the various indices – 5-year CDS and bond spreads In addition, the instability of the currency, an expansionary fiscal policy and inflation expectations around the upper limit of the price target also support the stability of the interest rate, while the risks to the inflation forecast continue to be biased mainly upwards in light of the ongoing limitations on the supply side, in particular in the market Housing and flights abroad.
“As far as the level of economic activity is concerned, the combined index published by the Bank of Israel, which provides an indication of the direction of economic development on a monthly basis, increased in May by only 0.04% and remains lower by regarding 1.6% compared to the eve of the war. The main engine of growth in the economy, private consumption, is struggling to recover Recently as reflected in the credit card spending indicators. One of the explanations for this may be the increase in the number of Israelis going abroad recently, but it is important to add that the credit indicators indicate a higher level of consumption compared to the eve of the war. Looking at activity at the aggregate level, it is not at all certain that lowering interest rates will help, since part of the damage to activity is caused by supply side limitations.
“Looking ahead, in order for the Bank of Israel to return to the path of interest rate reductions, we will have to see a relaxation in the geopolitical situation, including a decrease in fears of an escalation in the north, which will lead to a decrease in the risk premium, and in particular to a strengthening of the shekel, which will contribute to a decrease in inflation expectations.”
Shetrit further explains that: “In terms of investors who expected no change in the interest rate, the main interest in the interest rate decision today is the economic forecasts of the research division in light of the developments recorded since the last forecasts in April. Indeed, the interest rate forecast has been updated upwards as we estimated, when the Bank of Israel sees one interest rate reduction only to the level of 4.25% looking a year ahead compared to 3 interest rate reductions as estimated in the last forecast in April (recall that the last forecast was for the end of the first quarter compared to the current forecast for the end of the second quarter).”
“Also, the growth forecast has been revised downward, the unemployment rate upward and the inflation forecast upward. As far as the deficit forecast is concerned, the Bank of Israel estimates that the deficit will amount to 6.6% of GDP, in accordance with the target, but in our view the deficit will be higher, especially when the growth forecast for consumption Private consumption was updated downwards and public consumption upwards.”
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