Israel Holds Rates as War Fuels Inflation and Slows Economy

Galit Altstein
·3-min read

(Bloomberg) -- Israel left interest rates unchanged as it weighs a war-related economic slowdown and quickening inflation.

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The Bank of Israel held its base rate at 4.5% on Monday, in line with the estimates of all economists surveyed by Bloomberg. It was the monetary policy committee’s seventh straight hold and last decision of the year, with the next meeting scheduled for early January.

Governor Amir Yaron has said inflationary pressures brought on by the ongoing conflicts against Hamas and Hezbollah will likely keep rate cuts off the table until the second half of 2025. Israel’s annual inflation stood at 3.5% as of October, above the government’s target range of 1% to 3%, largely due to supply-side constraints.

The monetary committee said in a statement accompanying the rate decision that, according to forecasters’ projections, inflation will accelerate at the start of 2025 — when value added tax is set to increase — and is then expected to moderate toward the upper bound of the target range in the second half of the year.

“There are several risks of a possible acceleration of inflation: geopolitical developments and their impact on economic activity, prolonged supply limitations, volatility of the shekel, and fiscal developments,” said the committee.

On the political side, Israeli and US officials have said talks on a cease-fire with Lebanon-based Hezbollah have progressed in the past week. Israel’s security cabinet, led by Prime Minister Benjamin Netanyahu, will meet on Tuesday and may vote on an agreement, according to an Israeli official familiar with the matter, though it’s unclear if Hezbollah will accept a deal.

“Geopolitical uncertainty continues to pose difficulties for economic activity and is delaying the economy’s return to the level of activity that characterized it prior to the war,” the Bank of Israel said.

The shekel strengthened on reports that a Lebanon truce is near, gaining around 1.8% against the US dollar on Monday, the best performer in a basket of expanded currencies tracked by Bloomberg. A stronger shekel could further support a policy of holding rather than raising rates.

Construction, Farming

Above-target inflation has been driven in part by the construction and agriculture sectors, which have been hit by a shortage of Palestinian workers banned from entering Israel, causing rent and food prices to rise significantly over the past year.

Israel’s aviation market has also suffered with many international carriers avoiding the country, sending airfare costs soaring.

The inflation rate may rise to as high as 4% after the planned VAT increase in January and probably won’t fall back into the bank’s target range before the end of 2025, according to Yoni Fanning, a strategist in Tel Aviv at Mizrahi Tefahot Bank.

At the same time, the central bank sees the economy growing just 0.5% this year, down from its earlier projection of 1.5%.

The Bank of Israel noted the cabinet’s approval at the start of this month of the 2025 budget, with a planned deficit of 4.4% of gross domestic product. It includes fiscal adjustments totaling about 35 billion shekels ($9.6 billion), in accordance with the central bank’s recommendations. It still has to be approved by the parliament.

“The government’s approval of the budget is a significant step,” the bank said. “But it is important to maintain the framework that was approved by the government through the remaining legislative process.”

(Updates with central bank comments starting on fourth paragraph; cease-fire latest from sixth.)

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