The Monetary Committee of the Bank of Israel will announce its fifth interest rate decision this year on Monday. Since January, when the rate was cut by 0.25% to 4.5%, the Monetary Committee has refrained from implementing further cuts. Capital market sources and analysts currently believe that there will be no rate cuts this time either. Although the Bank of Israel itself in April presented a macroeconomic forecast of three rate cuts by the first quarter of 2025, after the upcoming announcement, only three more rate decisions before the end of 2024.
Why is interest rate cuts not expected?
The main reason behind expectations that interest rates will remain unchanged is Israeli economic data, primarily the risk premium, which shows that Israel’s situation is deteriorating. Modi Shafrir, chief strategist at Bank Hapoalim, says that Israel’s risk premium is reflected in the spread on Israeli dollar bonds, which jumped to 1.8% last week. “This compares to an average spread of 1.51% for bonds worldwide with a BBB- rating, which is evidence of our increased risk premium in the world.” Israel is currently more similar to a BB rating than to the official rating, in countries A. Shafrir adds: “With geopolitical uncertainty, expansionary fiscal policy, an increase in the risk premium and a weakening shekel, the Bank of Israel will not cut interest rates.”
The main factor the Bank of Israel focused on when considering interest rate policy was the stability of the financial markets, primarily the foreign exchange market and concerns about the weakness of the shekel against the dollar. Jonathan Katz, chief economist at Leader Capital Markets, says this is the most dominant consideration in the decision, even more so than inflation. “The shekel has weakened by more than 1.3% since the last interest rate decision, and when you have all the security risks and instability in the currency, it is clear that the interest rate cannot be lowered,” Katz says.
When will the price go down?
Economists and analysts believe that only when the shekel returns to the level of 3.6-3.65 shekels to the dollar, i.e. a decrease of about 5%, will it be possible to talk about cutting interest rates again.
The Bank of Israel’s research department in April forecast that the rate would be cut three times by the first quarter of 2025. But market instability and the escalation in the north have tempered market expectations, and now only one or two cuts are expected next year. Katz explains that if it weren’t for the risk factors in Israel, the dry data, especially after the May index was below expectations (2.8% inflation), points to monetary easing: “Core inflation without the government fell below 2%, so Israel’s position without the war would have been excellent in this sector.”
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Even in the current state of war, Katz insists that another cut is still on the table. “We saw the Bank of Israel do this in the middle of the war, in January. But in order to achieve further comfort, we will have to see relative calm in the geopolitical situation, whether it is a hostage deal or a ceasefire. Such calm strengthens the shekel and reduces the risk premium here, and the reduced fear of escalation in the north will also help with this.”
Such a situation is unlikely to occur before the Monetary Committee meeting, but it is certainly possible later this year. “Geopolitical issues are very difficult to predict,” says Katz. “If we see a ceasefire and at least some of the hostages returned, there will be a sharp reaction in the markets and we could then price in a rate cut later this year. Moreover, parallel cuts in the world and a more conservative fiscal policy, assuming the government decides on a package of measures for 2025, could also support this process.”
Is it possible that we will see a situation where interest rates rise?
Between May 2023 and January 2024, the interest rate stood at 4.75%, after rising from 0.1% in April 2022. At the moment, macroeconomists are not prepared to present even a theoretical blueprint for returning to raising interest rates. At the same time, such a question does not seem to concern the members of the Monetary Committee either. Bank of Israel Governor Prof. Amir Yaron told Globes in April that the current monetary policy is at a level that is sufficiently restraining for price levels in Israel. None of the committee members voted in favor of raising the interest rate in April.
As long as inflation does not surprise Israel and does not rise again, the Bank of Israel’s discussions will focus on whether to leave interest rates at their current level or cut them. The Bank of Israel still estimates that the war will end by 2025, and the assumption here is that its end will reduce the risks facing Israel and may herald more relief.
What is expected to change in the economic outlook next week?
Alongside the monetary policy decision, the Bank of Israel will issue an update to its economic forecast for April. Most notable among these is the interest rate forecast, as it is no longer reasonable for the interest rate to be 3.75% in less than a year. Katz estimates that the Bank of Israel will set the interest rate range within a year at 4%-4.25%. At the same time, growth forecasts are also expected to change. Katz believes that the forecast for 2024 will be slightly lowered from 2%, although the recovery forecast for 2025, at 5%, will remain unchanged. Inflation is also expected to rise, with an expected 2.7% at the end of 2024, which is very low. Bank Hapoalim estimates an interest rate of 4.25%-4.5% a year from now – one cut at most. Annual inflation, according to Hapoalim’s forecast, will remain at 3.3% over the coming year.
Another important element is the state budget deficit. In the Bank of Israel’s latest forecast, the deficit was 6.6%, as set out in the updated budget. “The Finance Ministry still believes that it does not expect any significant deviation from the target, and there is already an increase in tax revenues that supports this belief,” Katz says. “I think they may raise the forecast a little, but not significantly.”
This article was published in Globes, Israeli Business News – en.globes.co.il – on July 4, 2024.
© Copyright Globes Publisher Itonut (1983) Ltd., 2024.