Governor of the Bank of Israel Defends Interest Rate Decision Amid Bleak Outlook for the Future of the Economy

SadaNews Economy Translation - As the Bank of Israel announced it would keep the interest rate unchanged at 4.5% for the fourteenth consecutive time, the bank's governor, Professor Amir Yaron, held a press conference criticizing the policies of Finance Minister Bezalel Smotrich.

Smotrich stated earlier this month that he would reduce taxes if the interest rate is not lowered.

The Governor of the Bank of Israel, as translated by SadaNews Economy, regarded the current tax cuts as akin to drinking espresso after taking a sleeping pill.

In an analytical report on the economic situation in Israel, the Hebrew economic site Calcalist noted that, unlike most previous decisions, this decision was not previously known.

Many economic analysts in Israel expect the central bank to gradually begin lowering the interest rate.

The decision by the monetary committee to keep the interest rate high is expected to cause significant frustration among the business sector, which is experiencing a slowdown, as well as among households exposed to the core interest rate, and government members who are facing an election year and assessing short-term impacts.

Analysts indicate that the current interest rate decision is accompanied by macroeconomic projections, indicating that annual growth in 2025 will only reach 2.5%, compared to 3.3% in previous forecasts.

The Bank of Israel estimates that this year's deficit will reach 5.1%, which is lower than the new expected deficit ceiling to be approved in the Knesset in the coming days, which is 5.2%. The bank anticipates that inflation will reach 3% by the end of the year, compared to 2.6% in previous forecasts.

Economists at the Bank of Israel explain the slowdown in growth due to the "prolongation of the war," as translated by SadaNews.

The central bank's forecasts for 2026 are more optimistic, assuming a growth rate of 4.3%, but they are based on the assumption that fighting does not continue into the first quarter.

For the first time, economists at the central bank have placed a price tag on the prolongation of the war, stating that "another quarter of war prolongation leads to a quarter percentage point drop in GDP, a 0.1% increase in inflation, a slowdown in the reduction of interest rates, and an increase in government spending by 0.15% of GDP."

The economists estimate in their macroeconomic forecasts that the interest rate will reach 3.75% a year from now, which means that interest rates will be cut three times over the next year.

These expectations are largely in line with capital market expectations (3.8%) and the average expectations of the private sector (3.7%).

Regarding inflation, the monetary committee also confirmed that the inflation rate for non-tradable components is 3.6%.

The Israeli monetary committee has identified, as translated by SadaNews, four potential risks for accelerating inflation: "geopolitical developments and their impacts on the economy, increased demand alongside supply constraints (especially in the construction sector), financial developments, and deteriorating global trade conditions."

The Hebrew newspaper reports that the monetary committee is aware that its decision may face criticism and continues to explain the broad uncertainty surrounding the Israeli economy.

The committee members wrote: "The uncertainty in these forecasts is reflected in a wide array of security scenarios that pose risks to the forecasts in both directions."

The research department analyzes the risk of declining expectations, which could arise from the continued prolongation of fighting, as supply constraints persist and negatively affect sentiment towards Israel, indicating that the continuation of this situation will hinder investments and the recovery of economic activity, resulting in lower growth, increased budget deficit, and a rise in both inflation and interest rates.

The newspaper referred to the conference held by Governor of the Bank of Israel, Amir Yaron, who expressed after the interest rate announcement that he is aware of the criticisms his decision not to lower the rate is likely to attract.

The governor began his remarks by stating that the war poses economic challenges, and the way to face them lies in formulating responsible economic policies that generate economic growth.

The Hebrew newspaper points out, as translated by SadaNews, that with these statements, Yaron is in agreement with Smotrich's assertions emphasizing the need to lower the interest rate to stimulate economic activity, hinting that a decrease in the inflation rate below 3% does not fully change the picture, and there are still other risks.

He noted that the current low inflation rate is due to the high interest rate.

Regarding criticisms from the business sector, he said, "Wages in the business sector are on the rise, and this may negatively affect inflation moderation."

The governor addressed the Israeli government, stating that "the process of preparing the 2026 budget must be strengthened, and this should be based on a responsible framework that ensures the maintenance of the debt-to-GDP ratio, and there should be a reduction in the debt-to-GDP ratio in the 2026 budget."

The newspaper noted that the Israeli government refrains from promoting this budget, even though the law obliges it to present the state budget to the Knesset by the end of October.

He criticized Netanyahu's statements regarding the need for self-sufficiency and reliance on it, saying, "Feelings towards Israel have become more negative... Israel relies significantly on its relationships with the global economy in international trade, so Israel must do everything it can to strengthen its international standing. Israel does not want, and cannot be, a closed economy."

The newspaper viewed the Bank of Israel Governor's statements as an implicit call to end the war.