Bank of Israel Cuts Interest Rate by 0.25% Amid Geopolitical Shifts and Inflation Drop

The Bank of Israel announced on Monday a 0.25% reduction in the interest rate, lowering it to 3.5%, marking the second consecutive cut following a similar reduction in late May. This move aligns with economists' expectations and is the first series of cuts since January. Since the previous rate decision, significant geopolitical developments have influenced the central bank's considerations, including a US-Iran memorandum aimed at ending their conflict, a sharp decline in global oil prices to pre-conflict levels, and Israel signing a framework agreement with Lebanon.

The Israeli shekel experienced notable fluctuations, strengthening to a 30-year high below 2.8 shekels per dollar in late May before weakening nearly 6% in June, briefly touching the 3 shekels per dollar threshold. Market analysts attributed this depreciation to signals from the Bank of Israel about potentially faster rate cuts, a stronger US dollar amid anticipated Federal Reserve hikes, sharp declines in the US tech sector prompting institutional portfolio adjustments, and concerns over the US-Iran agreement conflicting with Israeli security interests. Additionally, the Bank of Israel intervened in the foreign exchange market in May, purchasing around $800 million.

On the inflation front, the consumer price index for May fell by approximately 0.3%, though annual inflation remained at 1.9%. Economists forecast June's inflation rate to range between -0.1% and 0.1%, projecting annual inflation to decline to about 1.6%-1.7%, within the Bank of Israel's target range of 1%-3%. This outlook supports arguments for a more accelerated pace of interest rate reductions, with most economists predicting the rate will reach 3% within a year, implying two additional 0.25% cuts.

Economists like Bank Hapoalim's chief strategist, Mudi Shapira, highlighted factors supporting the rate cut, such as Israel's still relatively high interest rates and economic damage from recent conflicts. However, he noted reasons against a larger 0.5% cut, including rising rents, a tight labor market, increased Israeli risk premiums, the shekel's sharp weakening, expected rate hikes in major developed markets, and the Federal Reserve's hawkish stance. Harel's chief economist, Ofer Klein, warned that a more hawkish tone from the Bank of Israel could lead to rising long-term yields if the rate cut is portrayed as a one-time move rather than the start of a cycle.

The Bank of Israel's decision reflects a complex balance of domestic inflation trends, currency fluctuations, and evolving geopolitical factors, with markets closely watching future monetary policy signals.