Bank of Israel keeps rates unchanged

The Bank of Israel has chosen to keep its benchmark interest rate unchanged at 4.75 percent, marking the first time in over a year that it has not raised rates. The decision was influenced by initial signs of inflation moderating, but the central bank warned that it may increase borrowing costs in the coming months if the uncertainty surrounding the controversial judicial overhaul raises the country’s risk premium and leads to continued weakness in the shekel.

Having previously raised interest rates ten times from a record low of 0.1% in April 2022, the Bank of Israel’s pause comes amid concerns over the rising costs faced by mortgage and loan holders as a result of the aggressive rate hikes.

Political uncertainty surrounding the proposed judicial overhaul has caused the shekel to weaken by almost 10% since the beginning of the year. The depreciation of the local currency raises the prices of imported goods, such as food and gas, and also contributes to higher inflation. Bank of Israel Governor Amir Yaron estimated that the shekel’s weakness has resulted in “excess” inflation of at least 1% to 1.5%. If this trend continues, the central bank may need to raise borrowing costs to control inflation.

Governor Yaron cautioned that the legal changes have increased uncertainty in the Israeli economy, leading to the devaluation of the shekel and underperformance of the local stock market compared to global markets. He emphasised the importance of restoring stability and certainty to the economy and ensuring that legislative changes are implemented with broad agreement to maintain the strength and independence of institutions.

The decision by the Bank of Israel was largely anticipated by the market, given the US Federal Reserve’s decision to refrain from further rate hikes in June and lower-than-expected consumer price increases in Israel. Economists suggest that the only factor that may lead to higher borrowing costs is the depreciation of the shekel.

Although inflation in Israel remains above the government’s target range of 1% to 3%, the Bank of Israel believes that the current interest rate level is restrictive enough to bring inflation back within the target range. However, if the shekel continues to weaken due to local uncertainty, a more restrictive monetary policy may be necessary.

The Bank of Israel’s research department revised its growth forecast for the economy, anticipating a growth rate of 3% for 2023 and 2024, assuming that disagreements over legislative changes do not have adverse effects. The forecast predicts a decline in annual inflation to 3% by the second quarter of 2024 and 2.4% by the end of 2024.

Governor Yaron, whose term is set to end in 2023, stated that he will announce his decision on whether to seek another five-year term around the Jewish holidays in September-October.

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