US Federal Reserve Rate Hike to Impact Israeli Economy, Currency

The US 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 US dollar and potentially lead to price increases for Israeli consumers. This decision marks a reversal from a period of declining rates and was made unanimously by the Fed's committee, despite pressure from President Trump to lower rates further.

The primary impact on Israel will be through the exchange rate. According to Ronen Menachem, chief economist at Mizrahi Tefahot Bank, a higher dollar interest rate compared to the shekel rate makes the dollar a more attractive investment. This can lead investors to shift funds into dollar-denominated assets, thereby weakening the shekel. Menachem noted that the shekel's attractiveness diminishes against both the dollar and the euro, which form the bulk of the currency basket affecting the average Israeli.

For Israeli consumers, a weaker shekel means 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 could also affect the Bank of Israel's monetary policy. While not necessarily preventing further rate cuts, it may slow the pace. The Bank of Israel has already lowered its rate four times this year. However, a weakening shekel raises concerns about imported inflation, limiting the Bank of Israel's room to maneuver. Menachem suggested this could delay further rate cuts, potentially pushing them into early 2027, which would also postpone relief on mortgage payments.

The Fed's rationale for raising rates includes persistent inflation in the US, partly attributed to energy price hikes following the conflict in Iran and tariffs imposed by Trump. Fed Chair Jerome Powell stated that inflation had been "too high, for too long" and the committee aimed to ensure a return to the 2% target. There is also a concern that prolonged high prices could lead the US public to normalize them, a situation the Fed experienced during the COVID-19 pandemic when it initially underestimated inflation.

While a rate hike by the Bank of Israel is considered unlikely due to concerns about strengthening the shekel too much and the current low annual inflation rate of 1.5%, savers holding dollar-denominated assets may see higher returns. However, this is accompanied by the risk that a strengthening shekel could erode these gains. Institutional investors managing public savings are also factoring the interest rate differential into their investment decisions.