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The Bank of Israel has maintained its benchmark interest rate at 4.5%, signaling its ongoing focus on balancing inflation amidst the economic disruptions triggered by the ongoing military conflict in the region. Inflation climbed to 3.4%, surpassing the central bank’s target range of 1-3%, due to mounting supply-side pressures. Military mobilization has caused significant labor shortages in key economic sectors, while disruptions in airline services further hampered commerce and supply chains. Despite these challenges, the shekel showcased resilience, outperforming major global currencies in late 2024. The combination of stringent monetary policy and measured fiscal interventions helped stabilize financial markets, although inflationary risks remain elevated due to the introduction of counter-cyclical fiscal measures, such as a 1% VAT increase and higher utility prices.
The central bank has revised its GDP growth expectations, raising its 2025 forecast to an optimistic 4% from the earlier projection of 3.8%. While the medium-term outlook appears promising, short-term growth remains subdued, with 2024 witnessing tepid expansion of just 0.6%. This sluggish performance underscores the complex interplay between accelerating government war-related expenditures and constrained consumer spending as citizens face higher costs for essentials. The central bank’s cautious approach reflects concerns that any premature monetary easing could stoke inflation further, especially given renewed external cost pressures linked to global supply chains and elevated energy prices tied to geopolitical tensions.
Encouragingly, there are signs of stabilization in Israel’s financial markets. The decreasing trend in credit default swap (CDS) premiums suggests improved investor confidence despite heightened government borrowing requirements to finance military operations. Additionally, the shekel’s consistent strength against major currencies points toward robust foreign exchange inflows, potentially from foreign aid and exports. These factors contribute to cushioning domestic economic challenges. However, policymakers remain wary of the long-term implications of the increasing fiscal deficit. Higher public expenditures for defense could strain public balance sheets, potentially impacting Israel’s sovereign credit ratings if economic recovery does not align with forecasts.
Governor Amir Yaron underlined the central bank’s intent to keep the interest rate within the 4-4.25% range throughout 2024 and possibly beyond, hinting that monetary easing is not expected until late 2025. His cautious guidance underscores the prioritization of macroeconomic stability over immediate growth stimulus. While the tightened policy regime could temper inflation and stabilize the shekel further, higher borrowing costs could pressurize domestic borrowers and businesses. Over the medium term, the central bank’s strategy will likely focus on managing inflationary expectations while addressing structural impediments such as labor shortages and fiscal imbalances exacerbated by the conflict. Overall, Israel’s ability to balance near-term geopolitical hurdles with prudent macroeconomic planning will dictate its economic trajectory in the coming years.
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