In a recent interview with Bloomberg at the economic conference in Davos, Bank of Israel Governor Prof. Amir Yaron shed light on the decision to lower the interest rate from 4.75% to 4.5%. The move, he explained, was driven by the perceived stabilization of markets and inflation. Yaron emphasized the importance of a cautious and moderate approach, indicating that future adjustments would depend on factors such as inflation trends, economic activity, fiscal developments, and geopolitical uncertainties.

The governor admitted that the interest rate cut was affected by the ongoing conflict, expressing concern that an escalation of the war with Hezbollah in the north of the country would compel a reassessment and maybe an increase in interest rates to ensure economic stability.

Despite the current challenges, Yaron asserted that interest rates worldwide, including in Israel, would likely stabilize at higher levels than before once the current cycle of rate cuts concludes. He stressed that this adjustment would be gradual, ensuring a slow and moderate transition to a higher real and nominal interest rate environment.

Addressing the recent state budget changes following the war with Hamas, Yaron commended the government for taking significant steps to offset the increase in expenses. He highlighted the importance of these measures in stabilizing the debt-to-GDP ratio, noting that the new budget would likely result in a debt-to-GDP ratio of 66% to 67%, providing a stable foundation for the market.

In related news, the Accountant General of the Treasury, Yehli Rotenberg, announced that Israel’s debt-to-GDP ratio for 2023 stood at 62.1%, surpassing market expectations. Despite concerns over increased expenses, Israel’s debt levels remain lower than those of most developed economies, positioning the country favorably in the global economic landscape.

However, Governor Yaron acknowledged the fiscal challenges posed by the war, estimating that the conflict directly costs 10% of GDP, including an increase of 1% in military spending.

Yaron also addressed the potential risk of renewed inflation within six months due to the war’s impact on demand and supply shocks in the economy. Despite these concerns, he expressed satisfaction with the current state of inflation, which moderated to 3%, entering the upper part of the Bank of Israel’s target range. Yaron remains optimistic, asserting that the negative demand shock from the war has expedited a soft landing, bringing inflation back into the target range faster than initially anticipated.

Main article photo: The Bank of Israel building Jerusalem. (REUTERS/Ronen Zvulun)