The Bank of Israel’s Monetary Committee has decided to keep the interest rate unchanged at 4.5%, marking the tenth consecutive month that the rate has remained at this elevated level. The decision aligns with the expectations of most analysts. This is despite a single interest rate cut in January 2024, from 4.75% to 4.5%. Additionally, the bank has revised its growth forecasts for 2025 and 2026, lowering its predictions by 0.5%, now forecasting 3.5% and 4% growth, respectively.
The bank’s decision to hold the interest rate at 4.5% is partly driven by ongoing inflationary pressures, with the annual inflation rate in February standing at 3.4%, above the target ceiling of 3%. The increase in inflation has been attributed to the impact of new taxes introduced in the 2025 budget. However, the bank predicts that inflation will fall below the target during the year, forecasting a decline to 2.6%.
Amir Yaron Comments on Global Economic Impact
At a press conference following the decision, Bank of Israel Governor Amir Yaron addressed the broader economic challenges posed by US President Donald Trump's tariff policies. Yaron noted that the global economy is undergoing a significant shake-up, with uncertain impacts on Israel. He emphasized that Israel’s exports are less exposed to tariff issues compared to other countries, which may help mitigate some of the effects.
Yaron acknowledged that a potential reduction in tariffs on Israeli goods, from 17% to 10%, would benefit Israel, but he stressed that the broader impact would depend on the overall scope of the tariffs and their effect on global trade. "The lower the tariff rate, the less economic damage to Israel will be," he explained. He also pointed out that much of the impact stems from a decline in global trade, not just the specific tariff on Israel.
Tariffs' Potential Impact on Inflation
Governor Yaron discussed how inflation in the US could spill over into Israel, particularly if the tariffs lead to higher US inflation. He also mentioned that fluctuations in the exchange rate could affect inflation in Israel, which might deviate from the downward trajectory that had been in place. The Governor added that the Israeli economy was previously on the right path to reduce excess demand, but changes in the global economy, including tariffs, might cause disruptions.
Yaron also addressed concerns about pension funds, pointing out that while short-term market volatility might affect asset values, long-term investments are spread across various channels and should be evaluated over the long term. He cautioned against making hasty decisions based on short-term market fluctuations, highlighting the strong performance of the S&P 500 over the past five years, despite recent declines.
Growth Forecasts and Economic Projections
The Bank of Israel revised its GDP growth forecast, expecting a 3.5% growth rate in 2025 and 4% in 2026. This is a downward revision compared to previous forecasts of 4% and 4.5%, respectively. The updated forecast assumes that global tariffs will reduce the volume of global trade by 4% by the end of 2026, which will have a moderate impact on Israel’s exports.
Inflation is expected to gradually return to the target range, with the rate projected to be 2.6% in 2025 and 2.2% in 2026. The interest rate is forecasted to average 4% by the first quarter of 2026.
The Bank of Israel's forecast assumes that the war in Gaza will not extend beyond the second quarter of 2025 and will not result in significant restrictions on the home front. However, should the conflict persist until the end of the year, defense spending is expected to increase by 2%, with a corresponding rise in the debt-to-GDP ratio, which would reach 71%.
Shekel Depreciation and Government Deficit
The shekel has depreciated by 4.3% against the dollar and 9.5% against the euro since the last interest rate decision, leading to a 5.8% depreciation in effective terms. Despite this, the government deficit decreased to 5.3% of GDP in February, mainly due to reduced war spending and higher tax revenues.
Uncertainty Around US Tariffs and Potential Impact on Inflation
Although the full impact of Trump's tariff policy remains uncertain, particularly in light of the upcoming meeting between Prime Minister Netanyahu and President Trump, initial assessments suggest that the tariffs could contribute to a decrease in inflation in Israel. This could occur due to lower consumption as a result of damage to public savings, as well as a reduction in prices for imported goods due to global supply surpluses from decreased trade with the US.
Given these dynamics, the latest developments may lead the Bank of Israel to adjust its interest rate policy sooner than previously anticipated, with the potential for a rate reduction in the coming months.
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