Weak shekel makes rate cut unlikely

Bank of Israel Governor Prof. Amir Yaron  credit: Eyal Izhar, Tali Bogdansky
Bank of Israel Governor Prof. Amir Yaron credit: Eyal Izhar, Tali Bogdansky

The weak shekel, the rise in Israel's risk premium, expansionary fiscal policy and geopolitical uncertainty all make a Bank of Israel rate cut unlikely on Monday.

On Monday the Bank of Israel Monetary Committee will announce its fifth interest rate decision this year. Since January when the rate was cut by 0.25% to 4.5%, the Monetary Committee has refrained from implementing further cuts. Capital market sources and analysts currently believe that this time too there will be no rate cut. Even though in April the Bank of Israel itself presented macroeconomic forecasts for three rate cuts by the first quarter of 2025, with after the upcoming announcement, only three more rate decisions before the end of 2024.

Why is no rate cut expected?

The main reason for the forecasts that the interest rate will remain unchanged is Israel's economic data, primarily the risk premium, which show that Israel's situation is deteriorating. Bank Hapoalim chief strategist Modi Shafrir says that Israel's risk premium is reflected in Israel's dollar bond spread, which jumped last week to 1.8%. "This is compared to an average spread of 1.51% for bonds worldwide with a BBB- rating, which is evidence of the increase in our risk premium in the world." Israel is currently more similar to the BB rating than the official rating, in A countries. Shafrir adds, "With the geopolitical uncertainty, the expansionary fiscal policy, the increase in the risk premium and the weakening of the shekel, the Bank of Israel will not cut the interest rate."

The main factor that the Bank of Israel focused on when considering its interest rate policy is the stability of the financial markets, primarily the foreign exchange market and concern about the weakening of the shekel against the dollar. Leader Capital Market chief economist Jonathan Katz says this is the most dominant consideration in the decision, even more than inflation. "The shekel has weakened by more than 1.3% since the last interest rate decision," says Katz, "and when there are all the security risks and instability in the currency, it is clear that the interest rate cannot be cut."

When will the rate fall?

Economists and analysts believe that only when the shekel returns to a level of NIS 3.6-3.65 per dollar, that is, a drop of nearly 5%, will it be possible to talk about cutting interest rates again.

The Bank of Israel research department forecasted in April that the rate would drop three times by the first quarter of 2025. But the instability of the markets and the escalation in the north have moderated market expectations, and now only one or two cuts are seen in the coming year. Katz explains that if it weren't for the risk factors in Israel, the dry data, especially after the May index which was lower than the forecasts (inflation of 2.8%), would point to monetary easing: "Core inflation without the government fell below 2%, so Israel's situation without the war would have been excellent in this sector."

Even in the current war situation, Katz stresses another cut is still on the table, "We saw the Bank of Israel do this in the midst of the war, in January. But in order for there to be further relief, we will have to see a relative calm in the geopolitical situation, whether it is a hostage agreement or a ceasefire. Such calm strengthens the shekel and lowers the risk premium here, a decrease in the fear of escalation in the north will also help with this."

Such a situation is not likely to happen before the Monetary Committee meeting, but later this year it will definitely be possible. Katz says, "The geopolitical issues are very difficult to predict. If we see a ceasefire agreement and the return of at least some of the hostages, there will be a sharp reaction in the markets and then we can price an interest rate cut later this year. On top of that, parallel cuts in the world and a more restrained fiscal policy, assuming that the government decides on a package of measures for 2025, can also support this process."

Could we see a situation in which interest rates rise?

Between May 2023 and January 2024, the interest rate stood at 4.75%, after climbing from 0.1% in April 2022. At the moment, macroeconomists are not prepared to present even a theoretical outline of a return to interest rate hikes. Meanwhile, such a question apparently does not concern members of the Monetary Committee either. Bank of Israel Governor Prof. Amir Yaron told "Globes" in April that the current monetary policy is at a sufficiently restraining level for price levels in Israel. Also, not one of the members of the committee voted for an interest rate increase in April.

As long as inflation does not surprise and resume rising, the Bank of Israel discussions will focus on whether to leave interest rates at the current level or cut it. The Bank of Israel still estimates that the war will end by 2025, and the assumption is that its end will reduce Israel's risk and can herald further relief.

What is expected to have changed in next week's economic forecast?

Along with the monetary policy decision, the Bank of Israel will issue an update on its economic forecast from April. Chief among them is the interest rate forecast with an interest rate of 3.75% in less than a year no longer seeming reasonable. Katz estimates that the Bank of Israel will set the interest rate range in a year at a level of 4%-4.25%. At the same time, the growth forecast is also expected to change. Katz believes that the forecast for 2024 will drop slightly from 2%, although the forecast for the recovery in 2025, at a rate of 5%, will remain unchanged. The inflation rate is also expected to rise, with the forecast of 2.7% at the end of 2024, too low. Bank Hapoalim estimates an interest rate of 4.25%-4.5% a year from now - that is, at most one more cut. Annual inflation, according to Hapoalim's forecast, will remain at 3.3% over the next year.

Another important element is the fiscal deficit in the state budget. In the most recent Bank of Israel forecast, the projected deficit was 6.6%, as defined by the updated budget. "The Ministry of Finance continues to believe that no significant deviation from the target is expected, and indeed there is an increase in the volume of tax revenues that supports this belief. I believe that they may slightly raise the forecast, but not significantly," Katz says.

Published by Globes, Israel business news - en.globes.co.il - on July 4, 2024.

© Copyright of Globes Publisher Itonut (1983) Ltd., 2024.

Bank of Israel Governor Prof. Amir Yaron  credit: Eyal Izhar, Tali Bogdansky
Bank of Israel Governor Prof. Amir Yaron credit: Eyal Izhar, Tali Bogdansky
Twitter Facebook Linkedin RSS Newsletters גלובס Israel Business Conference 2018