Bank of Israel Cuts Interest Rate by 0.25% for Second Consecutive Time in 2026

On Monday afternoon, the Bank of Israel announced a 0.25% reduction in the base interest rate, marking the second consecutive cut and the third since the start of 2026. The base rate now stands at 3.5%, with the prime rate at 5%. The Monetary Committee, led by Governor Professor Amir Yaron, chose to lower the rate despite ongoing political uncertainty and concerns about government spending ahead of the election announcement. This rate cut is expected to reduce monthly mortgage payments and ease borrowing costs for businesses affected by the ongoing conflict.

The Bank of Israel also released an updated macroeconomic forecast, projecting 4% economic growth in 2026 and 5.5% in 2027, revisions upward from March forecasts due to stronger-than-expected national accounts data in Q1. Inflation is forecasted at 1.8% for 2026, down from the previous 2.2%, influenced by a reduced risk premium following the end of Operation "Roaring Lion," a stronger shekel, and a sharp drop in oil prices after the reopening of the Hormuz Strait. The interest rate is expected to average 3% in Q2 2027, with two additional rate cuts anticipated during the year.

The budget deficit is projected at 4.9% of GDP in 2026 and 4.2% in 2027, with the debt-to-GDP ratio stabilizing around 69%. The baseline scenario assumes a 15 billion shekel increase in defense spending for 2026, slightly above the allocated reserve. However, the Bank warns that an additional increase of up to 25 billion shekels, as requested by the defense establishment, could raise the deficit, debt, and inflation by 0.2% to 0.5%.

Governor Yaron addressed the economic implications of the "Torah Guardians" law, emphasizing the importance of integrating the Haredi population into the workforce and military, noting that 7,500 additional Haredi recruits could add 10 billion shekels annually to the economy, equivalent to 0.5% of GDP. Finance Minister Bezalel Smotrich criticized the modest rate cut, calling it insufficient for the economic challenges and urging a sharper reduction to ease living costs and support the high-tech and export sectors amid a strengthening shekel.