Inflation is at a five-year low: Why is the Bank of Israel hesitant to cut rates?
In an interview with Bloomberg, Bank of Israel Governor Amir Yaron tempered expectations for monetary easing on September 1, despite inflation falling to a five-year low. While a strong shekel and low indices support a rate cut, the central bank remains cautious due to various economic and geopolitical risks.
Inflation is at a five-year low, sitting below the midpoint of the Bank of Israel's stability target (1%-3%). This figure would seemingly support a third consecutive interest rate cut at the upcoming decision on September 1. However, Governor Prof. Amir Yaron is signaling a different approach, suggesting that there is no need to rush.
In an interview with Bloomberg, the Governor highlighted several variables that could impact the decision, indicating that the conditions for further easing have not yet fully matured.
Inflation: The arguments for and against
The primary argument for a rate cut is inflation: the July index rose by 0.3%, with annual inflation falling to 1.5%. According to Bank of Israel data, this environment allows for less restrictive monetary policy than during the peak of the price hike wave.
Conversely, Yaron expects inflation to accelerate toward 2% in the coming months. Housing remains a risk factor, with the housing index rising 0.7% in July and rents for changing contracts jumping by 4.8%.
Rafi Gozlan, chief economist at IBI, notes: "The statement that inflation is expected to rise to 2% or more is a signal to the market: a cut is possible, but the interest rate adjustment process is nearing exhaustion." Jonathan Katz of Leader Capital Markets adds that if inflation rises due to fiscal adjustments, such as tax hikes, it does not necessarily require a hawkish monetary response.
The exchange rate as a central factor
The exchange rate remains a critical concern. Since the beginning of the year, the dollar has weakened by about 6% against the shekel, trading near the 3-shekel mark. While this is higher than the 2.8-shekel low recorded three months ago, it remains historically strong.
A strong shekel helps curb inflation via import prices but hurts exporters. The Bank of Israel may view a rate cut as a tool to balance export pressures, but an overly aggressive move could trigger devaluation and reignite inflationary pressure.
Growth and the labor market
The economy grew by 3.6% in the second quarter (15.4% annualized). However, Jonathan Katz warns: "When you strip out the activity of global tech giants like Nvidia, the economy looks significantly weaker." Private consumption remains below pre-war levels, reducing the urgency for monetary easing.
The labor market remains tight, despite unemployment rising from 2.9% to 3.1% in July. High demand for labor continues to support wage growth, which complicates further disinflation.
Geopolitical uncertainty
Governor Yaron emphasized the rising level of uncertainty regarding geopolitical and fiscal risks. Katz argues that the Bank of Israel views wars as inherently inflationary due to supply-side constraints. Developments over the next two weeks—regarding Iran, oil prices, and the exchange rate—will be critical to the committee's decision.
Ultimately, experts emphasize that the Bank of Israel remains a cautious body. The September 1 decision will depend heavily on whether the country can avoid extraordinary shocks in the security arena and financial markets.
