(Bloomberg) — Israel refrained from cutting interest rates on Monday, with the central bank on alert for risks of a wider war while an economic bounce-back this year adds to worries about inflation.
The monetary committee left the key rate at 4.5%, surprising most economists surveyed by Bloomberg, who expected a second straight reduction of a quarter percentage point. The shekel pared losses and traded little changed after the announcement.
The central bank repeated its guidance from January, saying it’s “focusing on stabilizing the markets and reducing uncertainty, alongside price stability and supporting economic activity,” according to a statement accompanying the decision.
“There is a great amount of uncertainty with regard to the expected severity and duration of the war,” it said. “The Committee’s assessment is that there are still a number of risks of a potential acceleration in inflation.”
A pause reflects the competing priorities pulling at policymakers as the war against Hamas approaches its sixth month. Though mindful of risks to the economy after a near-record contraction last quarter, the central bank has also warned that the government’s heavy spending in response to the conflict could be an obstacle to further monetary easing, in addition to concern over shekel volatility, geopolitics and credit rating downgrades.
Judging by the slowdown in price growth in recent months, ample room is available for the Bank of Israel to provide more stimulus. The Bank of Israel’s research department projects the interest rate at 3.75%-4% in the fourth quarter of 2024, an outlook that Governor Amir Yaron has said could imply as many as four cuts this year.
By skipping a rate cut, Israel also aligns more closely with policies of global central banks.
US Federal Reserve officials have recently made clear they are in no rush to reduce rates. Several policymakers at the European Central Bank are stressing that monetary easing can’t begin until more data arrives in the coming months.
Barclays Plc economists including Brahim Razgallah said before Monday’s announcement that a pause in Israel was likely “due to heightened geopolitical uncertainty, the delay in Fed cuts, gradual economic recovery and the Bank of Israel’s cautious communication.”
Relative calm has so far prevailed in Israeli markets, despite a downgrade earlier this month by Moody’s Investors Service, Israel’s first-ever sovereign rating cut.
Since that decision, the shekel has been the second-best performer among a basket of 31 major currencies tracked by Bloomberg, a rally helped by gains in global tech stocks. It’s trading at a level stronger than before the war, up more than 12% after reaching an 11-year low in late October.
Although Israel’s rate differential with the US shrank with a cut to start the year, its official borrowing costs are near 2% when adjusted for inflation, comparable to Canada’s and a bigger buffer than in developed economies from the UK to the eurozone.
Annual Israeli inflation was slowing or unchanged in all but one of the past 12 months, entering the government’s 1%-3% target range for the first time in over two years.
But a ramp-up in government spending is raising the risk of sticky inflation, especially if worker shortages endure, as higher shipping costs add to pressures.
The future course of the conflict presents the biggest uncertainty of all, highlighted by the threat that the fighting could spread along Israel’s northern border where its military has been exchanging fire with Iran-backed Hezbollah.
An economic slowdown at the end of last year also contrasts with signs of a quick rebound so far in 2024, especially in private consumption and a labor market that’s seen unemployment fall sharply since a spike in October. The Israeli Purchasing Managers’ Index in January shifted back into expansion from contraction, according to Bank Hapoalim.
“The Bank of Israel will wait for the April decision in order to continue reducing the interest rate,” Gil Bufman, Bank Leumi’s chief economist, said before Monday’s decision.
–With assistance from Joel Rinneby.
(Updates with shekel, central bank comments starting in second paragraph.)
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