Bank of Israel lowers interest rate to 3.5% in response to strong shekel, halt in war with Iran

The Bank of Israel's Monetary Committee announced a reduction in the national interest rate, lowering it to 3.50% from 3.75%. This decision follows a similar 0.25% decrease in May and is attributed to moderating inflation and the sustained strength of the Israeli shekel. The committee noted that inflation remained stable around the midpoint of the target range in May, with a risk premium similar to pre-October 2023 levels.

Despite the rate cut, some economic stakeholders, particularly exporters, expressed dissatisfaction, advocating for a more substantial reduction. Finance Minister Bezalel Smotrich criticized the move, stating, "The minimal reduction in the interest rate does not match the challenges facing households and businesses, is not connected to the needs of the economy, and makes it harder for the high-tech sector and exports." He argued that a sharper decrease would better alleviate the cost of living and counterbalance the shekel's appreciation.

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The inflation rate in May remained stable around the midpoint of the target range, and the risk premium is similar to before October 2023. Overall during the reviewed period, the shekel depreciated with high volatility.

The Bank of Israel also factored in the geopolitical landscape, specifically mentioning the Memorandum of Understanding between the US and Iran and the subsequent stabilization of energy prices and reduced geopolitical tensions. However, the bank acknowledged that uncertainty surrounding Iran persists, which had influenced its decision to maintain rates at 4% in March despite inflation being within the target range.

Looking ahead, the Bank of Israel Research Department forecasts GDP growth of 4% by the end of 2026, potentially rising to 5.5% in 2027. This projection is contingent on external budget considerations, particularly the defense budget. The department estimates the government's budget deficit to be 4.9% of GDP in 2026 and 4.2% in 2027, assuming the defense budget does not exceed the allocated buffer. Additionally, the housing component of the Consumer Price Index saw an annual increase of 4% in May.

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The minimal reduction in the interest rate does not match the challenges facing households and businesses, is not connected to the needs of the economy, and makes it harder for the high-tech sector and exports. A sharp reduction in the interest rate is the right step that will ease the cost of living and balance the strengthening of the shekel.