Israel’s central bank, in a pivotal move, has cut interest rates for the first time since the peak of the global pandemic in 2020. However, this decision is now overshadowed by concerns raised by the central bank regarding the government’s fiscal response to the ongoing conflict with Hamas. The war budget, if not managed carefully, poses risks of increased debt and potential hurdles to further monetary easing.
Interest Rate Cut Amidst Fiscal Warnings: The monetary committee, ending a pause since July, lowered the key interest rate to 4.5% from 4.75%. This move is seen as a response to support the economy, but concerns have been voiced about the fiscal implications of the ongoing conflict. The central bank has warned that a risky fiscal policy may impact future rate decisions, urging adjustments to reduce expenditure and boost income.
Budget Deficit and Revised War Costs: An updated outlook from the central bank’s research department reveals that the government is likely to run a larger budget deficit than estimated in November. The fiscal costs of the war against Hamas have also been upwardly revised to approximately 210 billion shekels ($58 billion). Governor Amir Yaron emphasizes the need for a prudent fiscal approach to prevent rising debt, increased yields, depreciation, and inflation.
Shift in Priorities: The decision to cut interest rates signals a shift in priorities, emphasizing economic support following efforts to stabilize markets post the Hamas attack in October. With a slowdown in inflation and the recovery of local assets, attention has turned towards supporting the economy. The shekel’s significant rally against the dollar in the past two months further indicates changing dynamics.
Future Monetary Policy and Economic Outlook: While the central bank gave no clear signal about the timing of future actions, policymakers aim to focus on stabilizing markets, reducing uncertainty, ensuring price stability, and supporting economic activity. Forecasts suggest the interest rate could range between 3.75% and 4% in the fourth quarter of 2024. The central bank envisions a more moderate path of rate decline compared to market assessments.
Risks and Caution: Risks abound as the central bank evaluates the implications of fiscal plans linked to the war, potentially resulting in a larger debt load. Discord with the government on budgetary adjustments may impact future decisions. The risk of the conflict expanding into a wider conflict adds another layer of caution, with ongoing disruptions across the economy.
Permanent Burden from Defense Outlays: Governor Yaron highlights a potential permanent burden from increased defense outlays, higher interest expenses, and long-term spending commitments associated with the conflict’s fallout. The government’s failure to make necessary fiscal adjustments poses the risk of a rising debt-to-GDP ratio in the coming years.
Call for Fiscal Adjustments: The central bank urges the government to make permanent fiscal adjustments, totaling about 30 billion shekels annually by the end of 2025, to ensure a decline in the debt-to-GDP ratio after 2025. Acting promptly to adjust the budget is deemed essential, as failure to do so may result in more significant economic costs in the future.
As Israel navigates the complex intersection of monetary policy, fiscal challenges, and geopolitical uncertainties, the decisions made in the coming months will play a crucial role in shaping the nation’s economic trajectory.
