Federal Reserve Rate Hike Signals Economic Ripples for Israel

The U.S. Federal Reserve has raised its benchmark interest rate for the first time since 2023, a move that is expected to weaken the Israeli shekel against the dollar and potentially lead to price increases for Israeli consumers. The decision, made unanimously by the Fed's committee, came despite pressure from President Trump to lower rates further. This policy shift by the Fed is anticipated to have global economic repercussions, including in Israel.

The primary impact on Israel will be through exchange rates. According to Ronen Menachem, chief economist at Mizrahi Tefahot Bank, a higher dollar interest rate while Israeli rates are falling makes the dollar a more attractive investment. This encourages investors to move funds into dollar-denominated assets, thereby weakening the shekel. Menachem noted that the shekel's attractiveness diminishes not only against the dollar but also the euro, both key components of the currency basket affecting the average Israeli.

For Israeli consumers, a weaker shekel translates to more expensive imports, including a significant portion of food products. Businesses that import goods will face higher costs, which they are likely to pass on to consumers. Conversely, Israeli exporters may benefit from the weaker currency.

The Fed's decision complicates the Bank of Israel's monetary policy. While the Bank of Israel has lowered its interest rate four times this year, a weakening shekel raises concerns about imported inflation, potentially slowing down or delaying further rate cuts. Menachem suggested that the next rate decision, scheduled for October 21, might see the Bank of Israel refrain from a cut due to its proximity to elections and the Fed's updated forecast, which projects a higher U.S. interest rate by the end of 2027. This wider interest rate gap between the U.S. and Israel makes it more challenging for the Bank of Israel to lower its own rates.

Menachem does not foresee the Bank of Israel raising its rates in the near future, citing the risk of strengthening the shekel too much and the current low annual inflation rate of 1.5% as reasons against such a move. For savers, holding dollar-denominated assets may offer higher returns due to the interest rate differential, though this carries the risk of currency fluctuations. Institutional investors managing public savings are also factoring this interest rate gap into their investment decisions.

The Fed's rationale for raising rates includes persistent inflation in the U.S., partly attributed to energy price hikes linked to the Iran conflict and tariffs imposed by Trump. Fed Chair Jerome Powell stated that inflation had been "too high, for too long" and emphasized the need to ensure it returns to the 2% target. The Fed also fears that prolonged high prices could lead the public to accept them as the norm, a lesson learned from the COVID-19 pandemic when initial price increases were underestimated.