US Inflation Surprise May Delay Israeli Interest Rate Cut

Higher-than-expected inflation data released in the United States on Tuesday could impact not only the Federal Reserve's upcoming interest rate decision but also that of the Bank of Israel. While the U.S. market is pricing in almost certain further rate hikes, including potentially a 0.5% increase in December, expectations in Israel still lean towards a rate cut as early as November 23. The upward surprise in U.S. consumer prices raises questions about the Bank of Israel's ability to lower rates while the world's largest central bank is moving in the opposite direction.

The U.S. Consumer Price Index (CPI) rose 0.4% in October, exceeding the 0.3% forecast. Although this is a slowdown from September's 0.6% monthly increase, the core CPI, excluding food and energy, climbed 0.3%, also above projections. This marks the third consecutive month of a 0.3% core CPI rise, indicating persistent price pressures beyond volatile energy costs. Fed Governor Christopher Waller suggested that a core reading of 0.3% or higher could justify considering a more aggressive half-point hike.

Yoni Panning, Chief Strategist at Mizrahi Tefahot's trading room, noted that U.S. rate expectations have converged around a 100% chance of another Fed hike in December. This contrasts with the Israeli market, which still factors in a possibility of a rate reduction in the near future. Panning stated that a further U.S. rate increase acts as a significant counterweight to any potential Israeli rate cut. Israel's current interest rate stands at 3.25%, compared to the U.S. range of 3.75%-4%. A quarter-point cut by Israel coupled with a similar hike by the Fed would widen the interest rate gap by an additional half-point in favor of the dollar, potentially strengthening it against the shekel and increasing imported inflation.

However, the Bank of Israel's policy is not solely dependent on the Fed. Israel's annual inflation was 1.6% in September, within its target range. Local economic activity, the exchange rate, and geopolitical risks will also influence the decision. Shmuel Katsabian, Chief Strategist at Discount Bank, highlighted a strong correlation between the shekel and the Nasdaq index, stronger than with other currencies. This connection, partly due to hedging activities by Israeli institutional investors, means the shekel's direction may not be solely dictated by interest rate differentials. Falling oil prices, with gasoline potentially dropping to $3.7 per gallon, could offer some relief, but lingering inflationary pressures from energy costs are still a concern.