The Bank of Israel is expected to leave short-term interest rates unchanged at a policy meeting next week, likely staying cautious after the Israeli military's resumption of strikes in Gaza and Lebanon.
All 14 economists polled by Reuters said they expected the central bank to keep its benchmark rate (ILINR=ECI), opens new tab at 4.5% when the decision is announced on Monday at 4 p.m. (1300 GMT).
While February inflation data were lower than market expectations, "an increase in geopolitical and domestic tensions will keep the Bank of Israel on the prudent side," said Morgan Stanley economist Alina Slyusarchuk, expecting the key interest rate to end 2025 at 4%.
Israel's annual inflation rate eased to 3.4% in February from 3.8% in January but remained about its 1-3% target.Inflation has stayed high due to price gains on a host of goods including water and electricity, as well as some taxes that rose at the start of 2025. The government also partly blames war-related supply issues for sticky inflation.
Hurt by the wars against Hamas in Gaza and Hezbollah in Lebanon, Israel's economy grew 0.9% in 2024 and is expected to grow 3.4% this year, according to OECD estimates issued on Wednesday. It also projects inflation at 3.7% this year and recommended policymakers hold the line on rates until price pressures were contained.
Central bank officials have said they expect inflation to ease in the second half of the year and hope to lower rates once or twice in 2025.
Israel's rising risk premium
But "markets have postponed the expected timing of the next rate cut in light of elevated risks," said Bank of Israel Chief Economist Victor Bahar, citing Israel's rising risk premium. He noted that the derivatives market is only pricing in one rate reduction this year.
Israel's high risk premium had fallen sharply since Israel agreed a US-backed ceasefire deal in January with Palestinian militant group Hamas, whose attack on October 7, 2023 triggered the war, but has risen again as the ceasefire deals could be in jeopardy.
After two months of relative calm, Israel resumed airstrikes on Gaza last month and sent ground troops back when the two sides failed to agree on the next stage of the ceasefire. On Wednesday, Israel announced a major expansion of military operations in Gaza.
An Israeli airstrike on Tuesday killed four people including a Hezbollah official in Beirut's southern suburbs, further testing a shaky ceasefire between Israel and Iran-backed Hezbollah in Lebanon.