The Bank of Israel kept the interest rate unchanged at 4.5% on Wednesday, the sixth consecutive time it has done so. The monetary committee’s decision to hold the rate was focused on “stabilizing the markets and reducing uncertainty, alongside price stability and supporting economic activity” in light of the continuing war, the central bank said.
The Bank of Israel also released its revised macroeconomic forecast, predicting that GDP growth in 2024 will be 0.5% and 3.8% in 2025, or 1 and 0.4 percentage point lower than previous forecasts, respectively.
The central bank also predicted that the deficit would be 7.2% of GDP in 2024 and 4.9% of GDP in 2025.
“The public debt is expected to reach a level of approximately 68% of GDP in 2024 and approximately 69% of GDP in 2025,” Bank of Israel Governor Amir Yaron said at a briefing following the decision’s announcement.
“GDP is 3.3% below the long-term trend line,” he said, adding that there was a moderate recovery in economic activity at the beginning of the third quarter.
The shekel has weakened by 2.8% against the dollar and 1.5% against the euro since the last monetary policy decision, Yaron said. Israel’s risk premium has increased sharply because of the escalation of fighting on Israel’s northern front, he said.
Underperformance in Israel’s equity market continued, despite improvement in recent weeks, he added.
Regarding the recent decision by Moody’s ratings agency to drop Israel’s credit rating by two notches to its lowest-ever rating, and S&P’s decision to drop Israel’s rating one level, Yaron said: “It is important to pay attention and take the assessments of the rating agencies seriously, as they reflect the challenges and risks faced by the Israeli economy as the world sees it.”
Inflation on the rise
“It is important that the government act to deal with the economic issues raised in the reports, which to a large extent are in line with the recommendations raised in the past by the Bank of Israel,” he said.
Yaron recommended that a responsible state budget for 2025 be approved, saying it was “an essential component in strengthening the international markets’ trust and maintaining the economy’s robustness.”
“It is important that the government and Knesset approve significant fiscal adjustments of a permanent nature,” he said, adding those steps are needed to offset the increase in defense expenditure and to allow the debt-to-GDP ratio to stabilize and then return to a downward path over the next two years.
The decisions by the ratings agencies reflect the geopolitical reality but also emphasize the importance of fiscal conduct, Yaron said.
Among considerations discussed when determining the interest rate was that inflation in Israel has been on an upward trend, in contrast to global trends, he said.
While further inflation is expected at the beginning of next year, expectations for the longer term are “within the target range,” he added.
Regarding the housing market, Yaron said home prices were continuing to rise, and the process of hiring foreign workers to fill construction labor needs has been slow.
“This issue has macroeconomic importance even beyond the construction industry,” he said, adding that “subject to security-related limitations and guidelines, steps should be taken, to the extent possible, to enable Palestinian workers to return to the construction industry.”
Regarding the labor market, Yaron said there were still labor supply limitations, and the “scope of military reserve call-ups has increased since the beginning of September.”
While the bank’s forecast is based on the assumption that the war will expand on the northern front and continue at high intensity at the beginning of 2025, the forecast is “characterized by a particularly high level of uncertainty,” he said.
More scenarios, including fighting that is prolonged and more intense than currently anticipated, were also examined by the monetary committee, and in these cases, there will be lower growth, higher inflation, and an increase in the deficit and in the debt-to-GDP ratio, Yaron said.