Bank of Israel Gets Green Light to Cut Interest Rates Amid Cooling Inflation
In June, Israel's Consumer Price Index (CPI) remained unchanged, leading the annual inflation rate to drop from 1.9% to 1.6%, moving closer to the Bank of Israel's target midpoint of 2% and nearing the lower bound of 1%, according to the Central Bureau of Statistics. This trend aligns with earlier forecasts and signals a continued cooling of inflation in the Israeli economy. Consequently, the Bank of Israel reduced interest rates to 3.5% on July 6, marking the second consecutive cut and the third since early 2026. With inflation at 1.6%, the real interest rate stands near 2%, still high compared to other developed economies, despite a 3.3% contraction in GDP during Q1 due to the "Roar of the Lion" military operation.
The June inflation data supports the Bank of Israel's Monetary Committee in potentially continuing rate cuts in the upcoming August 31 meeting, aiming toward a neutral interest rate around 3%, as projected by the Bank's research division. However, the inflation decline is largely driven by temporary and imported factors, including a 3.1% drop in fuel prices following a US-Iran ceasefire, a 5.2% decrease in fresh fruits and vegetables (notably a 33.8% plunge in watermelon prices), a 3.3% fall in clothing prices due to end-of-season sales, and a 1.6% reduction in overseas travel costs. These price drops reflect global market conditions and exchange rates rather than domestic economic improvements.
Conversely, non-tradable sectors continue to exert upward pressure on inflation. Housing costs rose by 0.7%, with owner-occupied housing services, the largest component, jumping 0.9% in one month, and new renters paying 6.6% more than their predecessors. Health services increased by 0.6%, hotel prices by 5.6%, dining out by 0.4%, and workplace meals by 4.2%. Basic food items such as cheese, cream, and meat also show steady price increases. Seasonally adjusted data indicates a 0.1% rise in June, with a 1.7% annual trend, underscoring persistent core inflation amid already high living costs.
The report highlights that the current inflation decline is largely due to external and seasonal factors, while local inflation drivers, especially housing, remain strong. Excluding housing, annual inflation falls to 0.9%, below the target floor. Geopolitical risks persist following the "Roar of the Lion" operation, and fiscal pressures are rising, with the Bank of Israel warning that a 25 billion shekel increase in defense spending could add 0.2% to 0.5% to inflation. The 2026 budget remains provisional. Therefore, the Monetary Committee is expected to continue reducing rates cautiously in quarter-point steps, balancing inflation risks despite calls from the Finance Minister for sharper cuts.
Additionally, the Central Bureau of Statistics reported a 1% monthly drop in housing prices, the steepest since early 2018, accelerating the annual decline to 2%. This development eases concerns that lower interest rates might reignite the housing market, providing the Bank of Israel with greater flexibility in monetary policy decisions.
