Bank of Israel to Cut Interest Rates: Psagot Economists' Forecast

Economists at Psagot Investment House have conducted an economic review, focusing on the upcoming decisions of the Bank of Israel regarding interest rates and providing their outlook.

"The renewal of fighting between the USA and Iran has raised oil prices again. Unlike the price surge in March, this time it is happening in parallel with a further weakening of the shekel. The exchange rate averaged 3.02 shekels to the dollar during the month, about 0.5% less than expected in our forecast. As a result, fuel prices in Israel in August climbed again to over 8 shekels per liter and will stand at 8.09 shekels, a monthly increase of 8.16%.

These changes added another 0.3% to the inflation forecast. The Consumer Price Index is expected to rise by 2.1% in the next 12 months. This forecast assumes no change in the exchange rate. As we saw during the days of the 'ceasefire', oil prices fell sharply. Therefore, we assume that oil prices will drop to a level of about 70 dollars per barrel at the end of the round of fighting between the USA and Iran.

The July index is expected to rise by 0.2% and inflation is expected to fall to 1.5%. The food item is expected to rise by 0.3%. The fruit and vegetable item is expected to rise by 0.5%. The housing item is expected to rise by 1.1%, while owner-occupied housing services are expected to rise by 1.3%. The apartment maintenance item is expected to fall by 0.4% and the furniture and household equipment item is expected to fall by 0.7%.

The clothing and footwear item is expected to fall by 4.7%. The education and culture item is expected to rise by 0.5%. The transport and communication item is expected to fall by 0.5%. The August index is expected to rise by 1.0% and inflation is expected to rise to 1.8%. The food item is expected to remain unchanged. The fruit and vegetable item is expected to rise by 1.5% for seasonal reasons.

The housing item is expected to rise by 0.8%. The apartment maintenance item is expected to rise by 0.4% and the furniture and household equipment item is expected to fall by 0.2%. The clothing and footwear item is expected to fall by 1.6% for seasonal reasons. The education and culture item is expected to rise by 0.9%. The transport and communication item is expected to rise by 3.9% following the rise in fuel prices and a seasonal increase of 8.3% in the flights abroad item.

Analysis and forecast: The developments in the US fighting in Iran are creating a shock in energy prices again. This time, unlike the shock that occurred in March, the changes in the exchange rate add to the rise in fuel prices at stations. Our assumption is that oil prices will return to falling after the round of fighting between the USA and Iran ends, as happened during the ceasefire days recorded last week.

Accordingly, it seems that inflation in July is expected to exhaust the downward trend, and then return to rising. The increase will be limited and will leave inflation in the center of the Bank of Israel's target even looking towards the end of 2027. However, the prolongation of the fighting, further weakening of the shekel, and pressures in the rental market tilt most of the risks to the forecast upwards.

To all this, it must be added that after the elections, discussions will begin again on the state budget and, in all likelihood, on increasing the defense budget, which could create additional inflationary pressures. In light of all this, we estimate that the Bank of Israel will reduce the interest rate twice more in the next 12 months, but will not rush to reduce the interest rate beyond that until the inflation picture for the medium term becomes clear."