Discount Bank Economists Warn of Interest Rate Changes in Israel

Economists at Israel's Discount Bank have issued a warning regarding potential interest rate adjustments, citing geopolitical uncertainty, energy prices, and global economic concerns. While noting some calm in government bond markets, they highlight that Israeli markets are pricing in a low probability of further interest rate cuts in early 2027. This outlook is influenced by upcoming elections, a stabilizing shekel, and global economic trends.

In the United States, the Federal Reserve's recent meeting minutes indicated broad support for a potential September interest rate hike, driven by strong demand and persistent supply shocks. However, policymakers are not favoring a prolonged or rapid series of increases. Despite recent moderation in inflation and labor market data, a further hike is still considered necessary by some officials, though not necessarily at consecutive meetings. Market expectations currently reflect over three hikes, leading to a projected interest rate of 4.7% within the next year. The ongoing conflict with Iran and its impact on oil prices add significant uncertainty to future inflation forecasts.

Globally, US Treasury yields have seen a moderate decrease, partly due to strong demand in long-term bond auctions. However, concerns persist in Europe, particularly regarding France's fiscal health amid political instability and difficulties in reducing its deficit. While tensions have slightly eased, the French 10-year bond yield remains elevated compared to German bonds. The European Central Bank has indicated it has tools to manage unjustified market panic, but intervention is not yet anticipated due to France's high deficit and relatively low yield spreads compared to past crises.

Domestically, Israel's high-tech sector continues to show resilience, with service exports experiencing a year-on-year increase despite a monthly contraction. High-tech export growth, though slower than before, remains positive, and companies anticipate an export recovery. Average salaries in the high-tech sector have risen significantly, indicating the sector's strength despite concerns about AI and a strengthening shekel. Overall wage growth in Israel is moderating, which economists believe supports low inflation.

Private consumption in Israel remains robust, with credit card purchases showing a notable increase in August. However, the Israeli bond market reflects international trends, with two-year yields falling and ten-year yields rising, influenced by US Treasury movements. The spread between US and Israeli ten-year bond yields has widened. Market expectations for Israel's interest rate anticipate a mere 25% chance of a cut in early 2027, with rate hikes expected to begin in September 2027. Discount Bank economists suggest it is too early to completely rule out another rate cut, given low inflation and modest inflation expectations, emphasizing that future interest rate decisions will depend on economic data, price indicators, and the geopolitical situation.