Isranomics

Shifting Economic Outlook for Israel in 2025

by | Jan 21, 2025 | Stock Market | 0 comments

Until recently, there was a broad consensus among economists regarding Israel’s economic trajectory for 2025. The general expectation aligned with the Bank of Israel’s forecasts, which predicted one to two interest rate cuts over the year and an inflation rate around 2.6% by the end of the year. However, the emergence of optimistic economic indicators has led to increased divergence among forecasters.

Recent weeks have seen a shift in economic sentiment, with forecasters now anticipating more significant interest rate cuts, potentially starting as early as April. The range of inflation forecasts has also broadened, reflecting the uncertainty in economic conditions.

The recent hostage deal and the ceasefire implemented on Sunday have further fuelled optimism about Israel’s economic prospects for 2025. The Tel Aviv 35 index has seen a nearly 6% rise in the past few weeks, and Israel’s risk premium, as measured by the 10-year Credit Default Swap (CDS), has decreased significantly. Since last October, following an Iranian drone attack, Israel’s CDS has dropped by 30%, indicating a reduced perception of default risk. Consequently, Israel’s bond yields have trended downward, with the 10-year yield at 4.2%.

The shekel has demonstrated notable strength recently, appreciating by 7% against the dollar since August. It has reached a two-year high against a basket of currencies from Israel’s major trading partners. On Monday, the dollar exchange rate fell to 3.58 shekels per dollar. A stronger shekel typically signals cheaper imports, which could help moderate inflation, although this effect is not guaranteed.

The December consumer price index provided a pleasant surprise, coming in at an annual rate of 3.2%, lower than the expected 3.4%. Despite this, inflation is expected to rise in the coming months, potentially approaching 4%, driven by recent tax increases. These include hikes in water, electricity, and property taxes, as well as an increase in VAT and vehicle purchase taxes. These measures are likely to reduce household disposable income and dampen private consumption.

Interest Rate Scenarios

Economists have updated their forecasts, presenting three possible scenarios for interest rate changes and inflation:

Bank of Israel Scenario: Predicts one to two interest rate cuts with inflation around 2.6%.

Moderate Scenario: Supported by Bank Hapoalim, Discount Bank, and Harel Insurance Company, this scenario anticipates two rate cuts and inflation ranging from 2.4% to 2.8%.

Optimistic Scenario: Backed by Mizrahi Tefahot, Leader Capital Markets, and Meitav, this scenario expects three rate cuts with inflation between 2.4% and 2.7%.

Jonathan Katz of Leader Capital Markets forecasts up to three interest rate cuts, beginning in April, with a potential reduction of the rate to 3.75% by year-end. He attributes the improved economic outlook to the strengthening shekel and easing supply-side constraints. However, Modi Shafrir of Bank Hapoalim highlights ongoing uncertainties, particularly concerning inflation and geopolitical developments. Shafrir expects inflation to reach 2.8% next year, with only two rate cuts anticipated.

While the Israeli economy shows promising signs of recovery and resilience, particularly with the strengthening shekel and positive market indicators, significant uncertainties remain. Inflation is projected to rise initially due to recent tax hikes but may stabilize later in the year. With various factors at play, including geopolitical stability and economic policies, sustained peace in the region will most definitely be key in realising a more optimistic economic scenario.

Image credit: freepik.com

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