Israel Set to Hold Rates as War Pressures Delay Easing Cycle

(Bloomberg) -- Israel’s central bank is set to hold interest rates for a sixth consecutive meeting, unable to join a global easing cycle as conflicts in Gaza and Lebanon increase inflationary pressures.

Most Read from Bloomberg

The Bank of Israel will hold its base rate at 4.5% on Wednesday, according to all 16 analysts surveyed by Bloomberg. Speaking at a conference last week, Governor Amir Yaron said cuts are unlikely before the second half of 2025, despite the economy slowing as war hits industries from tourism to agriculture and construction.

The Israeli shekel is down around 3.4% against the dollar since the end of August, one of the weakest performances globally. Israel’s risk premium, as measured by credit default swap contracts, is the highest in 12 years.

Markets have recently started pricing in the possibility of a rate hike, according to interest-rate swaps. Such a move would help the shekel. Still, most analysts doubt the central bank would consider that option at this stage.

In the six weeks since the last rate decision, Israel’s multi-front conflict has intensified. It’s sent troops into Lebanon and faced a ballistic-missile attack from Iran, which Prime Minister Benjamin Netanyahu has vowed his government will retaliate against. Fighting in Gaza continues, with cease-fire talks between Israel and Hamas stalled.

Moody’s Ratings downgraded Israel by two notches to Baa1 late last month. S&P Global Ratings followed days later with a downgrade of its own. Both companies cited the government’s soaring spending to fund the war effort.

The high cost of a prolonged conflict in Lebanon or with Iran will put even more pressure on the government’s stretched finances. The 2024 budget will be probably be revised for a third time before the year is out and may include a larger projected deficit than the original one, which was 6.6% of gross domestic product.

The 12-month trailing deficit stood at 8.3% of GDP in August. The full-year figure is likely to be one of the highest recorded by Israel this century.

Netanyahu’s cabinet is expected to approve the 2025 budget — which will likely include spending curbs and tax rises to offset higher defense needs — at the end October. It will then be put to parliament, where it needs to be approved by the end of March to avoid a collapse of the government.

Some taxation measures designed to increase revenues by around 13 billion shekels ($3.5 billion) have been outlined. But the government will need to make much bigger adjustments to meet a target deficit of 4% next year. There’s no guarantee Netanyahu’s far-right coalition members will agree to those.

“If fiscal policy continues to be expansionary, the Bank of Israel will have to balance it with a restraining policy, which means raising interest rates,” Leonardo Leiderman, an economic consultant to Bank Hapoalim, one of Israel’s biggest lenders, said this week in an interview with Israel’s TheMarker newspaper.

The main factor that could trigger a rate hike is Israel’s inflation, which accelerated to 3.6% year-on-year in August. That’s above the government’s 1%-3% target range.

“Looking at the various balances between lowering interest rates and raising them, there are reasons for a hike in Israel at this time,” said Leiderman, citing market forecasts that the inflation rate will climb to 5% in early 2025.

Most Read from Bloomberg Businessweek

©2024 Bloomberg L.P.