The Bank of Israel announced that the interest rate will remain unchanged and will continue to stand at 4.5%. This decision comes despite last month's first recorded 0.25% decrease since the coronavirus outbreak in April 2020.
According to Amir Yaron of the Bank of Israel, "The interest rate decision weighs several factors. Some of these factors work in opposite directions: Inflation is moderated and stands at 2.6%, slightly below predictions from the beginning of the war. According to predictions from January, the GDP was significantly affected in the last quarter of 2023, and the annual growth of that year amounted to 2%.
"On the other hand, the economy shows signs of recovery by several essential indicators: the state of the labor market, the activity in credit card usage, the combined index, and other activity data. Despite this, though, the uncertainty in the economy is still very high when considering the development of the war.
"We entered the war when inflation in Israel was still above target. Expectations for inflation for the coming year have risen slightly. Uncertainty still prevails regarding the effects of the war on inflation processes.
"With the outbreak of the war, we took a number of steps to ensure the proper functioning of the markets. These programs have so far succeeded in producing stability in the foreign exchange market and in the financial markets, as well as supporting households and business owners through the guidelines implemented in the banking system.
"Data from Central Bureau of Statistics shows that the GDP decreased significantly in the last quarter of the year 2023, and at the end of the year it grew at a rate of 2%. This change in the GDP was mainly affected by a decrease in the activity of the construction industry and private consumption. On the other hand, public consumption increased in the face of the war."
Regarding the downgrade, Yaron stated that "The decision was made considering when and how the war will end, the effect of the war in the Knesset in dealing with core economic and social issues, and the change in the fiscal situation. The reason for the uncertainty is due to the expansion of the war in the North."
"The State of Israel has experienced geopolitical crises during periods when debt/GDP ratios were much higher, and there was never any delay in the government's debt repayments. It seems that the risks described were already embodied in the market by investors even before.
"To strengthen the confidence of the markets in the Israeli economy, the government and the Knesset must act to address these economic issues. These are largely in line with the recommendations previously raised by the Bank of Israel and other entities. They will require necessary structural changes in government ministries.
"A responsible fiscal policy, which brought the economy to a GDP debt ratio of about 60% at the beginning of the war, is a strategic asset in economic terms. This ratio stands by us now when the economy has significant expenses as a result of the war. It is important to continue to maintain a responsible fiscal policy and to transmit this to the markets, who today are following activity in Israel more than ever."
What are the problems with Israel's state budget?
Regarding the state budget, Yaron said that "the updated budget is particularly challenging. The economic consequences of the war are broad and significant. In addition to the damage to the GDP, the war requires a very large increase in budgetary expenditures. In addition to the increase in the cost of war, a significant increase in the defense budget is also expected in the foreseeable future.
"This has great economic significance. The current budget is an important point of reference in strengthening the confidence of the international markets in the Israeli economy and preserving its stability.
"I reiterate the need for a committee that will map Israel's security needs in the coming years and formulate an appropriate multi-year budget plan.
"The committee should discuss the amount and composition of the defense budget, and I hope that the appointment of the committee will be completed as soon as possible," Yaron concluded.