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. The decision, made unanimously by the Fed's committee, came despite pressure from President Trump to lower rates. This shift in US monetary policy is anticipated to have ripple effects globally, including in Israel.

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 not only against the dollar but also against the euro, both key components of the currency basket affecting the average Israeli.

For Israeli consumers, a weaker shekel means more expensive imports. Since a significant portion of goods purchased in Israel, including food items, are imported, a decline in the shekel's value translates to higher prices on store shelves. While this benefits Israeli industrial exporters, it increases costs for importers, who often pass these expenses onto consumers.

The Fed's decision may also affect the Bank of Israel's monetary policy. While not necessarily preventing further rate cuts, it could 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, potentially limiting the Bank of Israel's maneuvering room. Menachem suggested this could delay further rate cuts, possibly until early 2027, and consequently postpone additional relief on mortgage payments.

The Fed's updated forecast, projecting a higher interest rate by the end of 2027 than previously anticipated, further complicates the Bank of Israel's situation by widening the interest rate gap. Despite these pressures, Menachem does not foresee the Bank of Israel raising its own rates in the near future, citing the risk of over-strengthening the shekel 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. However, this also carries the risk that a strengthening shekel could offset these gains. Institutional investors managing public savings are also factoring this interest rate gap into their investment decisions.