Bank of Israel holds rates but leaves hope for cuts this year

By Steven Scheer

JERUSALEM (Reuters) - The Bank of Israel kept short-term interest rates unchanged for a ninth straight meeting on Monday, but held out the prospect for further easing this year should inflation pressures subside, despite the conflict in Gaza.

The central bank - which has expressed worries about a higher investor risk premium since the start of the war with Palestinian Islamist group Hamas in October 2023 - left its benchmark rate at 4.50%, as expected.

It cited an annual inflation rate that rose to 3.8% in January from 3.2% in December "partly due to tax increases", adding that the rate is expected to move back into its 1-3% target range in the second half of the year. Water, electricity and transportation costs also rose at the start of 2025.

Yet, it cautioned that the labour market remains tight, as indicated by job vacancy, employment, participation and wage data.

The central bank reduced its benchmark rate by 25 basis points in January 2024 after inflation and economic growth slowed, but has since kept policy steady. The government blames the inflation rise mainly on war-related supply issues.

Israel's Manufacturing Association also said supply constraints in the economy, especially a shortage of workers - many of whom have been called into reserve duty - were driving inflation.

"The government must take urgent action to address supply constraints caused by labour shortages and declining productivity," said association President Ron Tomer, citing the removal of barriers to bringing in foreign workers and the rapid return of the missing workforce to the economy.

Bank of Israel Governor Amir Yaron has said Israel could cut rates once or twice later this year should inflation move back into its target.

For the time being, "In view of the continuing war, the monetary committee’s policy is focusing on stabilising the markets and reducing uncertainty, alongside price stability and supporting economic activity," it said.

The bank said Israel’s risk premium, as measured by the price of five-year credit default swaps and the spreads on dollar-denominated government bonds, continued to decline, but remained higher than before the war.

The economy grew by an annualised 2.5% in the fourth quarter, well below expectations, and 1% for all of 2024.

"Economic activity continues to recover moderately," the bank said. Its economists forecast 4% growth in 2025.

The shekel was 0.1% weaker versus the dollar at a 3.57 rate.

(Reporting by Steven Scheer; Editing by Hugh Lawson, Kirsten Donovan and Sharon Singleton)