Bank of Israel maintains interest rates amidst Gaza conflict, prioritises financial stability

The Bank of Israel Governor, Amir Yaron, provided insights on the economic impact of the recent conflict with Hamas. Despite acknowledging that Israel's economy would face challenges due to the war, he expressed confidence in a swift recovery. The central bank, in its third consecutive decision, chose to leave the benchmark interest rate at 4.75per cent.

According to Reuters, Yaron mentioned, "I'm pretty skeptical that at the moment lowering the interest rate would make demand jump" during a news conference.

The central bank's previous strategy involved raising interest rates for ten consecutive times, aiming to combat inflation. This strategy, which started in April when rates were at 0.1per cent, paused in July and August. Yaron highlighted concerns regarding further weakening the shekel, which was already at an eight and a half year low against the dollar. He expressed that steep rate cuts could exacerbate the situation and lead to increased inflation.

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The inflation rate had eased to 3.8 per cent in September, down from 4.1 per cent in August, but still above the annual target range of 1 per cent to 3 per cent. Bank of Israel's economists projected that inflation would decrease to 2.9 per cent in the coming year and settle at 2.5 per cent by the end of 2024. Yaron emphasised the need to stabilise the financial system to avoid repercussions on the real economy.

Rather than resorting to rate cuts, the Bank of Israel is taking alternative measures that act as monetary easing. These measures include collaborating with banks to allow those affected by the conflict to defer or freeze loan repayments. As per the Reuters, Yaron emphasised that addressing interest rates would come after the economy's recovery post-war, stating, "For now, uncertainty is very high."

Growth estimate and economic impact

The ongoing conflict, which began on October 7th with Hamas's attack on Israeli towns, has led the Bank of Israel to revise its growth estimates. The growth forecast for 2023 has been adjusted to 2.3 per cent, down from the previous estimate of 3.0 per cent, and 2.8 per cent for the following year, down from 3.0 per cent. These forecasts are based on the assumption that the conflict will remain concentrated in the south, specifically on the Gaza border, in the fourth quarter. Yaron stressed that the duration and expansion of the war into other regions, such as the Lebanese border or other areas, could significantly alter these estimates.

Yaron remained optimistic about Israel's ability to recover and return to prosperity. Reuters quoted him as saying, "We have known how to recover from difficult periods in the past and to return rapidly to prosperity. I have no doubt that it will do so this time as well."

Currency measures and fiscal restraint

The Bank of Israel is also taking steps to contain the shekel by selling $30 billion of foreign currency. With no expected change in interest rates, the shekel remained stable against the dollar at a rate of 4.06, its weakest since March 2015. Since the beginning of the war, the shekel has depreciated by 5 per cent, marking a total decline of 15.5 per cent in 2023.

While government officials have indicated their commitment to spend on the war and compensate those affected, Yaron cautioned about the importance of fiscal restraint. The central bank's projections indicate an increase in the debt-to-GDP ratio from 60.5 per cent in 2022 to 62 per cent in 2023 and 65 per cent in 2024. Yaron urged responsible fiscal policies and expense reductions in areas deemed less critical.

Credit Rating Concerns

In addition to economic challenges, Israel faces credit rating concerns. Fitch recently placed Israel's credit ratings on credit watch negative, while Moody's initiated a review for a possible downgrade.

(With inputs from Reuters)

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