Further rate cuts will be tough while inflation persists, says Bank of Israel’s Yaron

By Thomson Reuters May 27, 2024 | 12:05 PM

By Steven Scheer

JERUSALEM (Reuters) – The Bank of Israel will have a hard time continuing to lower short-term interest rates as long as inflation pressures persist and Israel’s war against Hamas remains uncertain and drives up government spending, governor Amir Yaron said on Monday.

The central bank earlier on Monday kept its benchmark rate at 4.5% for a third straight month, as had been widely expected.

Since a 25 basis point rate cut in January, the war – particularly on Israel’s northern border – has intensified, while fiscal spending has swelled along with higher inflation, prompting the central bank to keep rates steady at its February, April and May meetings, Yaron said.

“All these parameters are putting more of a burden on the process of interest rate normalisation because we are determined to not allow inflation to diverge,” Yaron said in an interview with Reuters.

In January, the central bank had forecast rates falling as much as one percentage point this year and Yaron said that still remains possible. “Things can change quite quickly around here,” he said, adding the rates path will be very data dependent.

Yet, “we don’t see the continued convergence of inflation, at least in the short run,” he noted.

Israel’s inflation rate edged up to 2.8% in April, still within the bank’s 1-3% target, but the rate had eased to 2.5% in February.

Yaron said the April data were highly influenced by the cost of air tickets and the central bank was looking to see whether that was a one-off factor or something more permanent. Core inflation that removes energy and food was also below the headline figure, while inflation expectations in the coming year or so were contained within the target, he said.

The rate cut process “is going to be very cautious and very measured” since policymakers seek the inflation rate easing towards 2%, Yaron said.

Fiscal policy is also a big concern for the Bank of Israel since war expenses have jumped, leading to a budget deficit of 7% of gross domestic activity in April – above a target of 6.6% that was revised sharply higher in the wake of the war that began after Hamas’s attack on Israel on Oct. 7.

Yaron, though, said that while spending has grown, tax revenue – due to a rebound in the economy – has been higher than expected. The deficit, he said, will continue to rise beyond 7% of GDP in the near term but likely end 2024 at current levels as long as there were no “notable security deviations in security expenses.”

The central bank sees a deficit of around 5% of GDP in 2025 and a debt to GDP ratio of some 68% of GDP.

As such, Yaron said, budgetary adjustments will be needed to keep the deficit under control and some will have to be brought forward should defence expenses rise significantly.

S&P last month cut Israel’s long-term credit ratings to A-plus from AA-minus, citing elevated geopolitical risks and projecting a budget deficit of 8% of GDP in 2024. That followed a ratings cut by Moody’s in February.

(Reporting by Steven Scheer; Editing by Susan Fenton)