By Brad Haynes

DAVOS (Reuters)

The Bank of Israel might lower short-term interest rates one or two times in the latter half of 2025, depending on inflation falling below 3%, Governor Amir Yaron mentioned on Wednesday.

Yaron stated that, despite recent positive inflation data (3.2% in December – just above the government’s 1-3% annual target), price pressures are expected to rise in the first half of the year before easing later in 2025.

> “We think in the first half we will see inflation still coming up and then moderating towards the second half into our target, which in our baseline case probably implies that in the second half, we could see somewhere between a cut or two cuts of interest,” Yaron said in an interview with Reuters during the World Economic Forum’s annual meeting.

The central bank dramatically raised the benchmark rate from 0.1% to 4.75% during 2022 and 2023 due to inflation spikes. It cut the rate by 25 basis points in January 2024, but it has remained at 4.5% mainly due to concerns over the impact of Israel’s conflict with Hamas, which intensified inflation, weakened the shekel, and increased Israel’s risk premium.

However, the shekel has appreciated 2.5% against the dollar this month, and ceasefires with Hamas and Hezbollah have substantially lowered Israel’s risk premium. Yaron commented on potential rate cuts, saying,

> “If we see inflation moderating faster and more significantly and the shekel strengthening in a more permanent way, then that may allow us to be a bit more agile and faster in that direction.”

GROWTH REBOUND EXPECTED IN 2025

Yaron indicated that while supply constraints due to the war that have increased prices are starting to improve, demand is likely to outpace supply in the short term. Israel experienced near-zero economic growth in 2024, but the central bank anticipates a growth of 4% in 2025.

Yaron warned that if inflation remains persistent, or if geopolitical tensions elevate Israel’s risk premium again, the bank would need to maintain a more restrictive stance longer. He highlighted the impact of increased value-added taxes and government-mandated hikes at the start of 2025, which could further pressure inflation.

He expressed concern over loose fiscal policies in 2024, primarily due to $25 billion in military spending, resulting in a budget deficit of 6.9% of GDP last year. However, Yaron praised the government’s austerity budget for 2025, which includes spending cuts and tax hikes aimed at reducing the deficit, though it requires final parliamentary approval.

He expects defense spending will increase the debt burden in 2025 but anticipates a decline in 2026. Yaron added,

> “Probably some more fiscal adjustment will be needed in the 2026 budget to assure that the trajectory of debt to GDP coming down continues onward.”

Following several credit rating downgrades in 2024, the government recognized the necessity of maintaining market confidence, although Yaron noted that the budget could have focused more on growth engines.