Israel’s Central Bank Says 2025 Budget Key to Setting Rate Path

(Bloomberg) -- Israel’s central bank is stepping up pressure on Prime Minister Benjamin Netanyahu’s government to take a growth-focused approach in next year’s budget as it weighs whether to tackle inflation with interest-rate hikes.

Most Read from Bloomberg

The Bank of Israel sees fiscal policy for 2025 as a determining factor in the path of inflation — which sits above the target range at 3.6% — and has been clear it won’t hesitate to increase rates if necessary, even with the economy slowing. That’s just one factor weighing on Finance Minister Bezalel Smotrich as he prepares for a milestone budget vote later this month and tries to reduce a soaring deficit pushed up by the cost of ongoing wars.

“We are looking very carefully to see the outcome of the 2025 budget deliberations, not just the headline figure of the target deficit, but also the composition of the expenditure and taxation that are meant to reduce the deficit,” Deputy Central Bank Governor Andrew Abir said in an interview. “We see positive steps led by the Finance Minister, but the proof of the pudding is in the eating.”

Netanyahu’s cabinet is expected to approve the 2025 budget — which will likely include spending curbs and tax rises to offset higher defense needs — at the end of October. It will then be put to parliament, where it needs to be approved by the end of March to avoid a collapse of the government.

The Bank of Israel held interest rates at 4.5% for a sixth straight month this week, unable to join a global easing cycle due to inflationary pressures. That’s even as the economy slows as ongoing wars in Gaza and Lebanon hit industries from tourism to agriculture and construction.

The Finance Ministry released data on Thursday showing a 12-month trailing budget deficit of 8.5% – putting the full-year figure on course to be Israel’s highest this century excluding the Covid-19 pandemic — and a bill totaling 103.4 billion shekels ($27.7 billion) for the first year of its war against Hamas in Gaza and Hezbollah in Lebanon.

Israel’s bond sales in the first three quarters of 2024 reached 222 billion shekels, putting the country on track to beat a debt-raising record of 265 billion shekels set two years ago.

“The government needs to send out a strong message that it’s serious about making changes that will support economic growth and allow Israel to bear the increased military burden,” said Abir. War spending has had a knock-on effect on investment, he said, and “the question is how can this be corrected.”

Netanyahu’s government is hampered by its alliance with ultra-orthodox parties, who are resisting calls for their supporters to join the army or labor market rather than stay in religious seminaries. The prime minister is also under pressure from nationalists, who will likely insist on diverting budgets to areas such as West Bank settlements.

Bank of Israel Governor Amir Yaron said in a press conference this week that if inflation rises more than expected the bank “may definitely raise interest rates.”

“The bank is left with a very narrow safety margin against upward surprises in inflation, so the probability of a future hike is non-negligible,” said Rafael Gozlan, chief economist at IBI Investment House Ltd.

Most Read from Bloomberg Businessweek

©2024 Bloomberg L.P.