Bank of Israel keeps interest rate at 4.5%, amid background of war

Israel's interest rate will remain at 4.5%, the Bank of Israel announced Monday.

The Bank of Israel (BOI) cited the gradual recovery of economic activity, the labor market, and rising price pressures as the reason.

It also applied a high economic risk premium within the rate due to the ongoing geopolitical uncertainty. 

The central bank kept its benchmark rate ILINR=ECI at 4.5%. It had reduced the rate by 25 basis points in January after inflation eased and economic growth was hit by the war, but kept policy steady in February and April.

Governor Amir Yaron indicated it would be difficult to lower rates further as long as inflation pressures persist and the war remains uncertain and drives up government spending.

"All these parameters are putting more of a burden on the process of interest rate normalization because we are determined to not allow inflation to diverge," Yaron told Reuters.

The rate cut process "is going to be very cautious and very measured."

All 15 analysts polled by Reuters had expected no rates move and many economists believe the rate could stay put for the rest of 2024.

"There has been some increase in the inflation environment," the central bank said in a statement. "Inflation expectations... for the coming year increased, and are around the upper bound of the target range."

"In view of the war, the monetary (policy) committee’s policy is focusing on stabilizing the markets and reducing uncertainty, alongside price stability and supporting economic activity," the bank said.

The interest rate will be determined by future inflation

The shekel ILS= was flat versus the dollar at 3.675, having strengthened from 3.83 to the dollar a month ago due to expectations of a delay in the monetary easing cycle.

It reiterated that the interest rate path will be determined by future inflation, and continued stability in the financial markets, economic activity, and fiscal policy.

When the bank cut rates in January, policymakers had believed the easing cycle would be gradual and result in cuts of up to one percentage point in 2024, but inflation has remained stubborn.

Morgan Stanley economist Alina Slyusarchuk said a 25 basis point rate cut could come in November with another 100 basis points in 2025. "The risks to our call are skewed to a delay, with the chance the cutting cycle would resume in 2025 only," she said.

Israel's annual inflation rate rose to 2.8% in April, still within its target range of 1-3%, after reaching 2.5% in February. The economy grew an annualized 14.1% in the first quarter from the prior three months after shrinking in the fourth quarter after the war broke out on Oct. 7.