Bank of Israel holds rates, warns over Israel's growing isolation

JERUSALEM — The Bank of Israel kept short-term interest rates unchanged on Monday, citing Israel's push deeper into Gaza along with persistent inflation, while warning over the impact of the country's growing global isolation.

The central bank held its benchmark rate at 4.50 percent for the 14th meeting in a row.

In a news conference after the decision, Bank of Israel Governor Amir Yaron cautioned that Israel's deteriorating reputation over Gaza could damage trade, foreign investment and the economy as a whole.

"Israel depends to a considerable extent on its participation in the global economy," Yaron said. "Therefore, Israel must do all that it can to strengthen its international standing, and thus ensure that the economy is open."

Despite pressure to lower rates from Israel's finance minister and industrialists in line with other central banks, Yaron defended the cautious stance, arguing that Israel was not the U.S. and monetary policy is guided by local conditions.

In particular, the bank pointed to geopolitical uncertainty due to Israel's ground offensive into Gaza City, with U.S. President Donald Trump and Prime Minister Benjamin Netanyahu set to meet later on Monday in a bid to end the two-year-old war.

Yaron warned that the continuation of the conflict would lead to further supply constraints and weigh on recovery.

"As a direct result, growth would be lower, the budget deficit would expand, and the paths of inflation and the interest rate would be higher," he said.

Last rate move in January 2024

The central bank's last move was to reduce the rate by 25 basis points in January 2024 after inflation eased and economic growth slowed in the early days of the Gaza war. It has kept policy steady since then and said it is in no rush to ease again while inflation remains at the upper bound of its target.

Israel's annual inflation rate eased to 2.9 percent in August from 3.1 percent in July, moving back to within the government's 1-3 percent annual target. At the same time, the economy contracted an annualized four percent in the second quarter.

The Bank of Israel's economists expect inflation to still be at three percent by the end of the year before slipping to 2.2 percent in 2026. It thinks the economy is poised to grow 2.5 percent this year, down from its prior estimate in July of 3.3 percent.

As a result, the bank's staff expect the interest rate to decline to 3.75 percent — or just two quarter-point cuts — in the next year.

Ron Tomer, head of the Manufacturers' Association, said it was time to re-examine monetary policy and whether it meets the current needs of the economy.

"At a time when exporters are facing cancellations of deals from partners in Europe, it is important to ensure that monetary policy does not add to these difficulties," he said.

After the decision, the shekel was one percent stronger versus the dollar.

Nine of 12 analysts polled by Reuters had expected no rate move on Monday. Three predicted a 25 basis-point rate cut on the heels of declining price pressures.

Reporting by Steven Scheer and Pesha Magid; Editing by Toby Chopra and Hugh Lawson