On Monday, the Bank of Israel lowered short-term borrowing rates for the first time in nearly four years. This interest rate cut decision, announced on New Year's Day 2024, not only made the Bank of Israel the first central bank to cut interest rates this year, but also made Israel the first developed country to announce a relaxation of monetary policy after the global interest rate hike in the past two years.
In 2023, many emerging economies, led by Latin American countries, have already begun the global interest rate cut wave, but before entering 2024, no developed economy has made a decision to cut interest rates. Although market participants currently have strong expectations for central banks of major developed economies to cut interest rates this year, traders generally expect the Federal Reserve and the European Central Bank to cut rates at least six times this year.
It is reported that the Bank of Israel lowered its benchmark interest rate from 4.75% to 4.5% on Monday, marking the first time since April 2020 that the bank has lowered rates, citing the stabilization of Israel's financial markets, a decrease in inflation rates, and weak economic growth since the outbreak of the Israeli Palestinian conflict on October 7.
Nira Shamir, Chief Economist of Israel Discount Bank, stated, "Prior to the interest rate cut decision on Monday, the Bank of Israel had been focused on financial stability. Now, they are taking more proactive (easing) measures - they are trying to help households."
Israeli Bank Governor Amir Yaron said that the pace of future interest rate cuts will depend in part on fiscal policy and how the Israeli government led by Netanyahu will adhere to responsible fiscal policies.
He pointed out that the defense and civil costs caused by war are expected to reach 210 billion shekels (approximately 58 billion US dollars), which will become a "budget burden" that needs to be addressed by reducing expenses in areas unrelated to war and increasing revenue (usually meaning higher taxes).
Yaron also stated, "If the market believes that Israel is heading towards a path of long-term debt growth, it is likely to lead to higher yields, currency depreciation, and inflation, thus requiring an increase in central bank interest rates."
He also criticized the government's inaction in making necessary budget adjustments (such as reducing excess ministries) so far, but he did not specify in detail which ministries he was referring to.
The Israeli Ministry of Finance had previously predicted that the budget deficit for 2024 would be approximately 6% of GDP. Yaron added that no action will be taken now It may cause greater economic losses in the future. What is needed now is to develop a responsible budget and make adjustments and decisions on priorities that are not easy to make; Quota;.
Further interest rate cuts still need time
Andrew Abir, Deputy Governor of the Bank of Israel, stated that although the decline in inflation rates and the recovery of financial markets have enabled the start of interest rate cuts, further easing will take time due to the impact of war and budget.
He pointed out that "the future will be even more difficult because there will definitely be a lot of uncertainty." We may be quite cautious in the future. We will observe its changes in silence. There is always a balance between monetary policy and fiscal policy. If fiscal policy is more expansionary, then monetary policy may need to take this into consideration.
Israeli Finance Minister Bezalel Smotrich praised the central bank's decision to cut interest rates on Monday, but seemed to ignore Yaron's call for budget discipline.
Smotrich said, "Over the past year, we have been implementing responsible fiscal policies that have contributed to the decline in inflation rates. Lowering interest rates now is to provide the necessary assistance for businesses and economic growth while addressing the Israeli Palestinian conflict."
It is worth mentioning that before the Bank of Israel announced its interest rate cut decision on Monday, industry analysts had inconsistent forecasts. Seven analysts surveyed by the media were expected to remain unchanged, while the other seven were expected to cut interest rates by 25 basis points.
In the past two years of tightening cycles, the Bank of Israel has raised interest rates a total of 10 times. Before April 2022, its benchmark interest rate was only 0.1%.
At present, the domestic inflation rate in Israel has slowed down from 3.7% in October to 3.3% in November, but it is still higher than the annual target range of 1% -3% set by the Bank of Israel.
The staff of the central bank also maintained a 2% economic growth forecast for 2023 and 2024, and set the economic growth forecast for 2025 at 5%. The bank stated that this year's inflation rate is expected to eventually slow down to 2.4%, and interest rates will gradually decrease from 4% to 3.75% by the end of the year.