Israel’s central bank has on Monday cut its short-term borrowing rates for the first time in nearly four years, while urging lawmakers to rein in spending, which has soared during the ongoing aggression on Gaza. It has lowered its benchmark interest rate by 0.25 percentage points to the new rate of 4.5 percent.
This is the first time the Bank of Israel reduced interest rates since April 2020. In a statement, the Israeli central bank has cited a stabilisation of financial markets since the outbreak of the war on October 7, falling inflation and weaker economic growth.
“In view of the war, the Monetary Committee’s policy is focusing on stabilising the markets and reducing uncertainty, alongside price stability and supporting economic activity,” the Bank of Israel’s statement read.
Budgetary burden amid war in Gaza
Nonetheless, Bank of Israel Governor Amir Yaron said the pace of future cuts partly relied on fiscal policy and how Prime Minister Benjamin Netanyahu’s government of far-right wing and religious parties would keep to responsible fiscal policy.
The defence and civilian costs of the Gaza war are expected to reach 210 billion shekels ($58 billion) and to be a “budgetary burden” that needs to be dealt with through spending reductions, Yaron told reporters. These reductions would be in areas that were not crucial to the war and by raising revenue, usually meaning higher taxes, he added.
“If the markets perceive that Israel is moving toward a prolonged path of rising debt it is likely to lead to increased yields, depreciation, and inflation, such that a higher central bank interest rate will be required,” Yaron stated.
Yaron, who was just approved for a second and final five-year term as Bank of Israel governor, also referred to the government’s inaction so far on making required budget adjustments, including cutting back redundant ministries, without giving details of which ministries he meant.
The Israeli Finance Ministry estimates a 2024 budget deficit of around 6 percent of GDP.
“Not acting now … is likely to cost the economy much more in the future,” Yaron warned. “What is needed now is a responsible budget that requires adjustments and decisions that are not easy regarding priorities.”
The Bank of Israel had raised rates 10 straight times in an aggressive tightening cycle that has taken the rate from 0.1 percent last April before pausing in July and again in August, October, and November.
In November, Israel’s inflation rate eased to 3.3 percent from 3.7 percent in October but remained above an annual target range of 1 percent – 3 percent.
Growth estimates
The Bank of Israel staff maintained economic growth estimates of 2 percent for both 2023 and 2024 and set a growth projection of 5 percent for 2025. They estimated that inflation would ease to 2.4 percent this year, while the interest rate is expected to gradually drop to 3.75 percent from 4 percent by the end of the year.
Following the rate cut decision, the shekel weakened 0.6 percent versus the dollar to a rate of 3.6225.
