Bank of Israel holds rates at 4.75% two weeks after surprise attack by Hamas

Central bank cuts economic growth forecast to 2.3% this year and 2.8% next, down from July estimates of 3% for both years, as war drags on

The Bank of Israel building in Jerusalem. Reuters

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Israel's central bank held its benchmark borrowing rate for the third consecutive meeting following a review of interest rates more than two weeks after attacks by Hamas prompted policy measures to stabilise markets.

The Bank of Israel held its short-term borrowing rates unchanged at 4.75 per cent. Borrowing costs are at their highest level since 2006.

“In view of the war, the monetary committee’s policy is focusing on stabilising the markets and reducing uncertainty,” it said.

“The war is having various economic effects, both on real activity and on the financial markets.”

Inflation is moderating, reaching an annual 3.8 per cent in September, but remains above the target range of 1 per cent to 3 per cent, data showed.

Israeli policymakers left interest rates unchanged as their focus remains on propping up the shekel.

The Israeli currency declined as much as 0.15 per cent to 4.0635 per dollar, extending its run of losses to an 11th day, the longest since 1984.

Slower economic growth

The Bank of Israel's research department on Monday cut its forecast for economic growth to 2.3 per cent this year and 2.8 per cent next, down from its July projection of 3 per cent for both years, due to the war’s macroeconomic impact.

The forecast is based on the assumption that most of the war’s direct impact on the economy will be seen in the fourth quarter of 2023 and that the conflict will be concentrated in the country's southern front.

“The impact is expected to be reflected in a further weakening of private consumption, due to the decline in demand for consumption and supply-side restrictions,” the Bank of Israel said.

“These restrictions are due to the absence of workers as a result of emergency mobilisations and the closure of educational institutions, as well as damage to physical capital and the ability to work in combat areas and threatened areas.”

Israel has called up 360,000 reservists – one of the biggest mobilisations in the past 50 years – as the conflict continues, following Hamas’s deadly assault on October 7. This reserve force draws on Israelis from all walks of life who work in every sector of the economy, including technology, tourism and start-ups.

Disruptions to manufacturing and supply chains are also expected, the central bank said.

“Industrial investment is expected to be harmed due to uncertainty and the increase in financing costs, as reflected in the increase in yields in the corporate bond market,” it said.

Investment in construction is also expected to be hurt due to restrictions on the entry of labourers and “due to the complete cessation” of employment of workers from Gaza, the banking regulator said.

Tourism is also set to suffer and, based on previous conflicts, this impact is expected to be prolonged, it said. With this decline in demand, imports are also expected to drop.

“Our assessment is that unemployment in the prime working ages will increase during the first part of 2024, before resuming its decline,” the Bank of Israel said.

Unemployment is forecast to reach 3.2 per cent in 2023 and 3.6 per cent in 2024, data showed.

The government budget deficit, meanwhile, is forecast to widen to 2.3 per cent of gross domestic product in 2023 and 3.5 per cent of GDP in 2024, from minus 0.6 per cent in 2022, according to the data.

Factors contributing to the budget deficit increase include a decline in tax revenue in the fourth quarter of 2023 and mainly in 2024 due to reduced economic activity.

“Our assessment in this forecast is that the government will, to some extent, reduce its other expenditures in order to offset some of the expenses and the increase in debt deriving from the war,” the central bank said.

“Furthermore, we assume that most of the defence expenditures in 2023 will be covered by allocations from within the budget and some use of assistance from the US government, but that starting in 2024, the defence budget will increase, which will result in an increase in the budget deficit.”

Government debt is expected to increase to 62 per cent of GDP at the end of 2023 and 65 per cent of GDP at the end of 2024.

“If the government decides to further increase expenditures and/or to avoid reducing other expenditures, the deficit and debt are expected to increase further accordingly,” the regulator said.