Since the outbreak of the war, Israel's risk premium has jumped while the capital markets have responded to the large black cloud hovering over the Israeli economy. Citi investment bank believes that the Bank of Israel will cut the interest rate next week by 0.75% in an aggressive move to support investment and credit taking in Israel. Such a hike would also reflect the large concern by the Bank of Israel in the fragile situation of the economy and businesses.
At the same time, there has been a jump in the cost of the Israeli government's CDS (credit default swaps). CDS is a financial instrument that estimates the risk of bankruptcy and is used as one of the ways in which a risk premium can be measured. The Israeli government's 10-year CDS rose this week to 130 basis points, compared with 85 points just two weeks ago. In November 2022, the cost of Israel's CDS was only 65 basis points, half of what it is now.
Another parameter that indicates the expected increase in Israeli risk is the yield spread between the 10-year Israeli government bond and its US counterpart - a spread that jumped by 50 basis points this week.
However, Bank Hapoalim chief economist Victor Bahar stresses that bond yields are actually falling. The ten-year bond yield fell to about 4.2%, compared to 4.5% before the war. Two-year bonds fell from a yield of 4.5% to 3.8% today. Bahar said, "This development is surprising in view of the increase in the risk premium, and due to expectations that the budget deficit will increase significantly." It should be noted that one of the explanations for the fall in yields in the short term is the forecast by many economists of an interest rate cut by the Bank of Israel.
Bahar sums up what is happening in Israel's economy, "It is difficult to explain even in retrospect some of the developments, including the strengthening of the bond market."
Goldman Sachs does not agree with this assessment in the market, the bank. The US investment bank believes that in the interest rate decision next week the Bank of Israel will leave the interest rate unchanged at 4.75%, despite the apparent slowdown in the market following the war in Gaza and the surprisingly low September inflation data published this week, which showed that the annual inflation rate has fallen to 3.8%.
Goldman Sachs writes, "Due to the amount of foreign exchange reserves held by the Bank of Israel, we believe that the bank will be cautious in its operations on the market, given the financial instability and depreciation pressures."
Analysts note that interest rate cuts will only be made when the Bank of Israel is confident that the market is stable. For example, the Bank of Israel will have to take into account that government spending will increase to help the economy get out of the crisis and rehabilitate the country after the war.
Published by Globes, Israel business news - en.globes.co.il - on October 16, 2023.
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