Bank of Israel Holds Interest Rate Steady at 4.5% Amid Economic Uncertainty

The Bank of Israel has decided to maintain its key interest rate at 4.5% for the seventh consecutive time, reflecting the ongoing economic uncertainty and geopolitical challenges. The decision follows an upward revision of the state budget deficit for 2025 and persistent inflationary pressures within the Israeli economy.

The current interest rate, which is 6.0% for prime lending, remains unchanged as the Bank of Israel continues to monitor domestic and global economic developments. Forecasters do not anticipate any immediate changes to the interest rate in the first monetary policy decision of 2025, which is scheduled for January.

Geopolitical Uncertainty and Inflationary Pressures Impact Economic Outlook

In a statement issued alongside the rate decision, the Bank of Israel highlighted that “the ongoing geopolitical uncertainty continues to complicate economic activity and delays the economy’s return to pre-war levels of growth.” The statement also addressed the recent government decision to increase the 2025 deficit target from 4.3% to 4.4% of GDP, citing the need to maintain fiscal discipline during the legislative process.

The annual inflation rate in Israel currently stands at 3.5%, one of the highest in developed countries. This is expected to rise further in the coming months, in contrast to expectations of a gradual decline in inflation in the US and Europe. The Bank of Israel’s Research Department has identified two primary reasons for the expected rise in inflation:

1. Base Effects from Last Year: Inflation in the final months of 2023 was unusually low, with the November 2023 index falling by 0.3%, December's by 0.1%, and January 2024 showing a zero index. As these low indices drop out of the 12-month calculation, inflation is expected to climb significantly, with projections reaching 4.5% by January 2025.

2. Upcoming Price Increases: Several key price hikes are set to take effect in early 2025, including a potential increase in the Value Added Tax (VAT) by up to 2%, alongside higher prices for electricity, water, property taxes, public transportation, and fuel. These increases will further add to inflationary pressures across the economy.

Bank of Israel's Cautious Approach to Monetary Policy

The Bank of Israel has remained cautious in its interest rate policy since the global inflationary surge following the end of the COVID-19 pandemic. While the central bank raised the interest rate multiple times in 2023 and 2024 to combat inflation, it made a small 0.25% cut in January 2024.

The Federal Reserve in the US, by contrast, recently lowered its interest rate by 0.25% to a range of 4.5%-4.75%, following a drop in US inflation to 2.4%. For the first time in a long period, US and Israeli interest rates are now at comparable levels. However, the Bank of Israel has signaled that further rate increases may be necessary if inflation exceeds its current forecasts.

Governor of the Bank of Israel, Prof. Amir Yaron, indicated that any future rate cuts in Israel are unlikely before the third quarter of 2025. Even then, rate reductions are expected to be modest, with a potential decrease of 0.25%-0.5% by the end of the year. If inflation continues to trend higher than expected, further rate hikes could be on the horizon in early 2025.

Israel Faces Rising Inflation and Economic Pressures

Israel's economic landscape remains challenging as the country grapples with high inflation, a growing budget deficit, and uncertain geopolitical conditions. With inflation expected to rise in the coming months, the Bank of Israel's cautious stance on interest rates reflects its effort to balance price stability with the ongoing economic recovery.

As the new year approaches, both policymakers and market analysts will be closely watching the global economic climate, domestic inflation trends, and the government's fiscal policies to gauge the potential for further adjustments to Israel's monetary policy. The government’s fiscal response, including the recent budget revision and anticipated spending increases, will play a key role in shaping the country’s economic trajectory into 2025.