Bank of Israel Cuts interest Rates Again as Inflation Eases - Governor Strikes Upbeat Tone

An interest rate decision day is typically one of the most demanding on the Governor of the Bank of Israel, marked by hours of deliberations, drafting statements, a lengthy press conference, and a round of media interviews late into the evening. This time, however, the day ended on a notably calmer note.

For one of the few times in recent years, Governor Prof. Amir Yaron appeared before the public as a bearer of good news, announcing a second consecutive interest rate cut and offering an unusually positive assessment of the Israeli economy — without sharp warnings or confrontational remarks toward the government.

Second Cut in a Row

The Bank of Israel’s Monetary Committee on Monday cut the benchmark interest rate by 0.25 percentage points to 4%, citing easing inflationary pressures. Inflation currently stands at 2.4%.

The move follows a similar cut on Nov. 24, when the central bank lowered rates for the first time in nearly two years, from 4.5% to 4.25%.

Improved Economic Outlook

Alongside the rate decision, the central bank significantly upgraded its economic forecasts. Gross domestic product is now expected to grow by 5.2% in 2026 — half a percentage point higher than the previous forecast — and by 4.3% in 2027.

Inflation projections were also revised downward, to 1.7% in 2026 and 2% in 2027, reflecting what the bank described as a more benign inflationary environment.

Independence Underlined

At the press conference, Yaron emphasized that the decision to cut rates again was not influenced “in the slightest” by political or public pressure. Observers of the central bank note that the Monetary Committee resisted repeated calls to cut rates throughout much of the past year and a half, underscoring its commitment to price stability.

That credibility, analysts say, helped pave the way for the latest move — even as inflation is expected to approach 3% in December. Yaron reiterated that the bank would not hesitate to pause or reverse course if inflationary risks re-emerge.

Why Inflation Risks Are Contained

The Monetary Committee cited three main factors supporting its assessment that inflation risks remain manageable.

First, the strengthening shekel is helping to curb import prices. While the governor noted that the pass-through to consumer prices in Israel is relatively low, a stronger currency still makes price increases harder to justify.

Second, labor market pressures have eased. Participation rates are rising, fewer workers are absent due to the war, and wage growth in the business sector has slowed — reducing upward pressure on prices.

Third, housing prices continue to decline. The bank expects this trend to persist despite lower interest rates, citing ample supply, a large inventory of unsold apartments and increased construction starts.

Limited Room for Further Cuts

Despite the upbeat tone, the central bank signaled that further rate cuts are likely to be gradual. Bank officials, along with market analysts and private forecasters, expect the benchmark rate to stand at about 3.5% by the end of 2026 — implying only two additional cuts.

Yaron attributed this to the so-called “neutral interest rate,” the level consistent with stable inflation and sustainable growth. While the neutral rate in the United States is around 3%, he estimated Israel’s at roughly 3.5% or slightly higher.

In practical terms, Yaron reiterated a message he has delivered repeatedly: the era of near-zero interest rates is over.

Gentler Criticism of Fiscal Policy

The governor struck a notably restrained tone in addressing government fiscal policy, though his concerns were clear. He urged lawmakers to approve the state budget without raising the deficit ceiling above 3.9% of GDP, warning that doing so is critical to maintaining market confidence.

While acknowledging that the current deficit target is itself disappointing and does not reduce the debt-to-GDP ratio, Yaron said his focus was on immediate, practical messages. The Bank of Israel forecasts that the debt ratio will not decline in 2026 or 2027, despite strong growth projections.

The softer rhetoric marks a shift in style rather than substance, analysts say — possibly reflecting political realities ahead of expected elections before the 2027 budget. Still, the governor signaled that he intends to continue speaking clearly on fiscal discipline in future policy decisions.