What will the Bank of Israel do if the worst happens?

Bank of Israel raises interest rate credit: Shutterstock
Bank of Israel raises interest rate credit: Shutterstock

The central bank has published scenarios for the economic consequences of the judicial overhaul, but has not said how it will deal with them.

The forecast of the Bank of Israel Research Department is unusual in its severity in comparison with what we have become accustomed to seeing in previous interest rate announcements. This time, the tone is completely different, and much more pessimistic, with the focus on the far-reaching changes that the government is introducing in Israel’s legal system.

In the best scenario, which the Research Department describes as one in which "the dispute regarding the legislative changes concerning the judicial system is resolved in a way that does not have any effect on economic activity going forward," the central bank’s interest rate is seen at 4.75% in a year’s time, while GDP is expected to grow by 2.5% in 2023 and 3.5% in 2024, with unemployment rising slightly. An interest rate that high has not been seen in Israel for 20 years, and furthermore around the world the talk is of halting and even reversing interest rate hikes.

What will happen, however, if the worst prognostications of the economic consequences of the judicial overhaul are realized? The Bank of Israel warns that GDP could be cut by 2.8% in each of the next three years, but does not set out what it will do if that happens.

The Research Department writes: "In the second scenario, the Research Department presents an analysis of the potential economic implications if the legal and institutional changes are accompanied by an increase in the country’s risk premium, a negative impact to exports, and declines in domestic investments and in demand for private consumption. This scenario is accompanied by a higher level of uncertainty than the standard forecast, regarding the intensity and persistence of the shocks. Therefore, the analysis is presented over a single three-year bloc. The forecast presents an indication of the impact on economic developments and its scale in the coming three years. In a case where the effect of the changes subsides relatively quickly, the impact is estimated at an average of about 0.8 percent of GDP per year over the three-year period being examined. In a case where the perception of the public (the financial markets, the real sector, and consumers) is that the impact of the legislative changes will persist, the impact is estimated at an average of about 2.8 percent of GDP per year over the coming three years."

The big question is, what will the Bank of Israel do if this scenario materializes? How high will interest rates go to douse inflation, and will the Bank of Israel sell dollars to stop the shekel from depreciating? There are no clear answers.

What the Bank of Israel does say is that, in the pessimistic scenario, its interest rate will rise more sharply, depending on the extent of the damage. The effect is estimated at an extra 0.5-1.9% each year, a fairly wide range. The Bank of Israel might have been expected to provide a full picture of the horror forecast, and to say how it is preparing to meet it.

Published by Globes, Israel business news - en.globes.co.il - on April 4, 2023.

© Copyright of Globes Publisher Itonut (1983) Ltd., 2023.

Bank of Israel raises interest rate credit: Shutterstock
Bank of Israel raises interest rate credit: Shutterstock
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