The Bank of Israel Lowers Interest Rates, Urges Fiscal Discipline

The Bank of Israel Lowers Interest Rates, Urges Fiscal Discipline

The Bank of Israel has made the decision to lower short-term borrowing rates, marking the first time in almost four years that the central bank has eased monetary policy. This move makes Israel the first developed country to lower interest rates. While the bank cited a stabilisation of financial markets since the outbreak of the war with Hamas, declining inflation, and weaker economic growth as reasons for the rate cut, it also strongly urged lawmakers to rein in spending that has escalated during the ongoing conflict.

Bank of Israel Governor Amir Yaron emphasized that the pace of future rate cuts would depend partly on fiscal policy and the government’s commitment to responsible fiscal management. Yaron expressed concern about the budgetary burden that the war with Hamas would impose, estimating that the defence and civilian costs would reach 210 billion shekels ($58 billion). To address this burden, he stressed the importance of reducing spending in areas that are not crucial to the war and raising revenue, which often means implementing higher taxes. Yaron warned that failure to take action in managing the budget could lead to increased yields, depreciation, and inflation, necessitating a higher central bank interest rate.

Critical Analysis of Government Inaction

Yaron highlighted the government’s lack of action thus far in making necessary budget adjustments, such as cutting back redundant ministries, without providing further details. The Finance Ministry projects a budget deficit of around 6% of GDP for 2024. Yaron emphasized that delaying necessary measures would ultimately cost the economy much more in the future. He stressed the urgent need for a responsible budget that requires difficult decisions regarding priorities.

Deputy Governor Andrew Abir acknowledged that falling inflation and a recovery in financial markets have created conditions for rate cuts. However, he also recognized that the ongoing war and the future of the budget introduce significant uncertainty. Abir expressed caution, stating that they would closely monitor developments before making further monetary policy decisions. He emphasized that there is always a delicate balance between monetary policy and fiscal policy, and if fiscal policy becomes more expansive, the central bank needs to take that into consideration.

Finance Minister Bezalel Smotrich welcomed the rate cut but appeared to dismiss Yaron’s call for budget discipline. Smotrich attributed the decline in inflation to the responsible fiscal policy pursued over the past year. He argued that lowering interest rates would support the growth of businesses and the economy while the war with Hamas continues.

Market Expectations

Ahead of the rate decision, analysts held divergent views, with some expecting no change and others predicting a 25 basis point reduction. The central bank had previously raised rates for ten consecutive times before pausing in July and making subsequent pauses in August, October, and November. Inflation slightly eased from 3.7% in October to 3.3% in November, remaining above the annual target range of 1%-3%. The Bank of Israel maintained its economic growth estimates for 2023 and 2024 at 2% each and projected 5% growth for 2025. Inflation is expected to decrease to 2.4% this year, and the interest rate is projected to gradually fall to 3.75% from the current 4% by the end of the year. Following the rate decision, the shekel weakened 0.6% against the dollar.

The Bank of Israel’s decision to lower interest rates for the first time in nearly four years reflects its cautious approach to managing the economy amidst the ongoing war with Hamas. The central bank’s call for fiscal discipline and responsible budget adjustments highlights the importance of addressing the budgetary burden and potential economic risks. The future trajectory of monetary policy remains uncertain, depending on how the government responds to these challenges. Market analysts are closely monitoring developments and adjusting their expectations accordingly while the Bank of Israel continues to navigate these complex economic conditions.

Economy

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