Bank of Israel Maintains Interest Rate at 4.75% Amidst Mixed Economic Signals

The Monetary Committee of the Bank of Israel has chosen, for the second consecutive time, to keep the interest rate steady at 4.75%. This decision aligns with market expectations and comes amid a backdrop of dwindling inflation, which dropped to 3.3% in July, juxtaposed with concerning signs of an economic slowdown.

In today's interest rate announcement, the central bank acknowledged that inflation is moderating, although it remains above its target range. Simultaneously, the Gross Domestic Product (GDP) maintains a level of activity exceeding pre-COVID-19 trends. Nevertheless, the committee pointed out that the growth rate falls below the economy's potential, with decreased total demand and several indicators hinting at a possible growth deceleration.

The Bank of Israel's report highlights that private consumption in Q2 2023 grew modestly at 1.9% annually compared to the previous quarter, primarily attributed to an increase in Israelis' overseas consumption—largely categorizing as an import of tourism services. Additionally, indicators signaling "a certain moderation in growth" encompass the Central Bureau of Statistics' business trends survey, which, while still positive, has become less optimistic. Furthermore, credit card spending remains below trend, and tax collection for July 2023 is approximately 5.5% lower in real terms than the same period last year.

The Monetary Committee emphasized that the shekel's recent devaluation has contributed to rising inflation and that its trajectory in the coming months will impact inflation dynamics. However, they also noted that global and domestic monetary tightening processes are working to temper inflation.

The Bank of Israel pointed out that local stock indices continue to underperform in comparison to global benchmarks, alongside indications of a slight increase in credit risk for medium, small, and micro-businesses. Moreover, the high-tech industry's capital raising has significantly decreased in recent years, aligning with global trends.

This interest rate decision could be one of the final actions for current Bank of Israel Governor Prof. Amir Yaron, as his term concludes in December. Despite ten consecutive interest rate hikes between April 2022 and May 2023, the committee perceives the current interest rate as constraining, anticipating moderate inflation in the medium term, even if it experiences slight near-term increases.

However, the committee also stressed the potential for future interest rate hikes based on inflation data. According to the Bank of Israel's research division forecast from last July, the interest rate could range between 4.75% and 5% by mid-2024.

The primary reason behind the Bank of Israel's interest rate decisions is the significant depreciation of the shekel exchange rate, which has intensified in recent months. A weaker shekel against the dollar can expedite inflation due to higher import prices. Additionally, the interest rate differential between Israel and the USA, where rates range from 5.25% to 5.5%, remains a critical factor. The President of the US Federal Reserve, Jerome Powell, has recently emphasized the potential for further rate hikes in the United States until inflation returns to 2%.