Bank of Israel Forecasts Single Interest Rate Cut in Coming Year

The Bank of Israel's Monetary Committee decided to maintain the interest rate at 3.25%, a move anticipated by most economists. This follows three consecutive rate reductions in May, July, and September. More significantly, the bank's research division projected a macroeconomic forecast indicating an average interest rate of 3.0% by the third quarter of next year. This suggests only one quarter-point rate cut within approximately a year from the current level. For those with Prime-rate mortgages, this translates to a potential decrease to around 4.5%.

The bank acknowledged considerable uncertainty regarding factors that could impact the economy, particularly assuming a low intensity of fighting and a tense geopolitical environment. The forecast explicitly excludes potential effects from upcoming Israeli elections. The previous forecast from July had predicted a 3.0% interest rate by the second quarter of next year, implying two rate cuts from the then-current 3.5% rate. The current forecast pushes this target back by a quarter, indicating a slowdown in the pace of rate reductions.

Several external factors contribute to this revised outlook. The assumed price of a Brent crude oil barrel has surged to approximately $110, a significant increase from the $72 projected in July. Furthermore, the bank estimates developed countries' interest rates will reach 3.5% by year-end and 3.4% by the end of next year, up from earlier projections of 3.0% and 2.9%. Higher global interest rates limit the Bank of Israel's flexibility to lower rates without weakening the shekel.

Inflation forecasts were revised downward for the short term, with an expected 1.5% by year-end compared to 1.8% previously. However, this is partly due to a temporary government reduction in fuel excise taxes. Longer-term inflation is expected to rise to 2.1% by the end of next year, influenced by oil prices, shekel depreciation, and the reintroduction of taxes. Financial markets and private forecasters generally align with the bank's inflation and interest rate expectations, though some predict rates could remain higher than current levels.

The bank also highlighted a significant discrepancy in GDP growth figures. While the forecast shows 5.6% growth this year and 7.5% next year, the bank adjusts this downward to 3.4% and 5.1% respectively, after excluding "overseas production." This refers to advanced technology products manufactured abroad by subcontractors based on Israeli R&D, often by foreign-owned multinational corporations. The bank argues this adjusted figure better reflects domestic economic activity, as overseas production does not utilize local capital or labor and its profits largely flow to foreign shareholders, thus not necessarily improving citizens' income or household welfare.

Despite the adjusted figures, the projected growth rates of 3.4% and 5.1% are considered robust. However, the bank cautions that the labor market remains a constraint, with the workforce participation rate, particularly among young, non-Haredi Jews, still below pre-war levels. Unemployment is expected to average 4.6% this year, but decrease significantly in the latter half. The recovery is expected to be bolstered by the entry of more foreign workers and the return of those who temporarily left the labor market. Investment and private consumption are projected to increase, while public consumption growth is expected to be modest.