Israel’s conflict with Hamas has disrupted expectations for Israeli short-term interest rates, as policymakers grapple with a weakening shekel, a slowing economy, and inflation above target. Initially, analysts predicted a rate hike in early 2024 after a series of tightening measures. However, after Hamas launched a deadly attack on Israeli civilians, expectations shifted towards rate cuts. The uncertainty surrounding the conflict and its impact on financial markets and economic activity has created risks for the rates outlook.
The lack of clear guidance from the Bank of Israel has heightened uncertainty. Prior to the attack, markets had priced in a 40% chance of a rate hike at the October 23 meeting. However, the shekel’s decline and the inflationary pressure prompted the Bank of Israel to launch a $30 billion intervention to stabilize the currency. Despite these measures, the market now expects rate cuts by the end of the year, as Israel assesses the economic toll of the conflict.
The preparation for a potential ground invasion of Gaza has halted activity in Israel’s tourism and construction sectors, and the call-up of reservists has affected the wider workforce. The central bank has already revised its economic growth estimates for 2023 and 2024, assuming the war remains contained. The Tel Aviv Inter-Bank Offered Rate (TELBOR), which reflects interest rate expectations, now suggests the market anticipates rate cuts over the next 12 months.
Bank of Israel Governor Amir Yaron stated that rate cuts are unlikely during the war, emphasizing the defense of the shekel and the importance of market stability. He argued that measures targeting deferred loan repayments already constitute a form of monetary easing. Credit default swaps, which insure against a sovereign default, have increased significantly since the start of the war.
The central bank’s economists project rate cuts in the next year, but prior to the conflict, markets anticipated more substantial rate reductions as inflation returned to its target range. Meanwhile, the Federal Reserve’s indication of higher interest rates for a longer period is influencing global borrowing costs. Israel’s next rate decision is scheduled for November 27, with expectations of rates being held steady.
While the Bank of Israel will eventually need to ease policy, analysts believe the scale of easing may be less aggressive than initially anticipated. Policymakers face the challenge of balancing the need to support credit growth with the high risk premium and the significant fiscal response to the war. They must also mitigate the secondary effects of supply shocks on inflation. Overall, uncertainty remains high regarding the future path of interest rates in Israel.
More detail via Reuters here… ( Image via Reuters )