In today’s decision, the Monetary Committee of the Bank of Israel opted to maintain the country’s interest rate at 4.75%, marking the fourth consecutive time the rate has remained unchanged. The decision reflects a cautious approach, considering the ongoing war and its potential impact on the economy.

Macroeconomic Forecast and Fiscal Implications

Governor Amir Yaron provided an update on the Bank of Israel’s macroeconomic forecast, acknowledging the optimistic nature of the October forecast despite the prolonged war scenario. The revised projections foresee a GDP growth of 2% in 2023 and 2024, slightly lower than the previous estimates. However, the deficit is anticipated to rise to 3.7% this year and 5% in 2024 (which is higher 1.4% and 1.5% respectively), reflecting the increased government expenditures associated with the war.

The Bank estimates war-related expenses at approximately 160 billion shekels, with a projected loss of revenue around NIS 35 billion. This financial burden contributes to a negative impact on private consumption, which is expected to decrease by 0.5% this year and 2% in the following year. The unemployment rate is also anticipated to rise, reaching 4.3% in 2023 and 4.5% in 2024, particularly affecting industries like tourism, construction, and overall production capacity in war-affected regions.

Economic Challenges and Adjustments

The Bank of Israel recognizes the complexity of forecasting during times of war, emphasizing the high level of uncertainty related to the war’s duration, scope, and nature. The economic damage is expected to be multifaceted, affecting both the supply and demand sides of the economy.

On the supply side, the war’s impact includes decreased labor supply due to mobilization of reserves, restrictions on workers entry, and disruptions in various sectors. Demand-side challenges are anticipated due to negative consumer sentiment and a likely prolonged downturn in tourism services export.

Governor Yaron stressed the importance of adjusting the budget to the evolving situation, urging the government to make decisions promptly to support a continuous reduction of the debt-to-GDP ratio. While acknowledging the need for fiscal responsibility, he emphasized the significance of permanent adjustments to address the anticipated increase in defense spending even beyond the war.

Interest Rate Decision and Economic Stability

Despite expectations of interest rate cuts due to the economic slowdown triggered by the war, the Bank of Israel opted to keep rates steady. Governor Yaron highlighted the need for stability in the foreign exchange market and financial markets, emphasizing that using the interest rate tool recklessly could increase volatility.

The decision is consistent with the Bank’s recent involvement in currency markets, where it sold dollars to maintain stability in the shekel. Economic signals, such as improved economic activity and increased credit card transactions, influenced this decision. Despite this, the Bank is exercising caution and anticipates a possible reduction in interest rates in early 2024 as the economic situation stabilizes. Some optimistic forecasts by experts suggest that this reduction could be as much as 1.5% in the coming year.

In conclusion, Israel faces economic challenges stemming from the prolonged war, requiring careful fiscal and monetary management. The government’s commitment to responsible fiscal policies, permanent budget adjustments, and adaptation to evolving economic conditions will be crucial in navigating the uncertainties ahead.