Bank of Israel expects to hold rates amid rising inflation

Israel’s central bank is set to keep interest rates on hold at 4.5% for the 11th time in a row amid an uptick in inflation to 3.6% and increased military operations in Gaza. The annual inflation rate rose last month from 3.3% in March, above the central bank’s target range of 1% to 3%, and economic growth in Q1 was slightly higher than expected at 3.4%.

The Bank of Israel is expected to leave short-term interest rates unchanged at its policy meeting today after inflation accelerated last month amid economic uncertainty exacerbated by Israel’s war against the Palestinian militant group Hamas.

Analysts polled in a Bloomberg survey predicted rate stability through the end of the year due to high inflation and market uncertainty. All 14 economists polled by Reuters also said they expected the central bank to keep its benchmark rate (ILINR=ECI) at 4.5% when the decision is announced on May 26 at 4 p.m. (1300 GMT).

CitiGroup’s Nies says interest rate cuts may be on hold until later in the year

Bank Hapoalim economist Victor Bahar said the Bank of Israel is currently closer to the Fed than to the European banks, that is, in a wait-and-see position. He added that Israel’s monetary policy will also be fairly coordinated with the Fed, assuming that the tariffs in the U.S. will not remain in place for long.

Bank Hapoalim’s Financial Division also said in a note to clients last week that the Bank of Israel would find it difficult to reduce the interest rate as long as inflation exceeded the target. Hapoalim claimed it is reasonable to assume the first cut would come toward the end of summer.

Rafael Gozlan, chief economist at IBI Investment House Ltd. in Tel Aviv, also expected monetary policy to remain tight, adding that recent developments had significantly increased the probability of rate stability through the end of the year.

“The Bank of Israel will leave policy unchanged until it has significantly more conviction that loosening will not reignite inflation.”

–Michel Nies, Economist at CitiGroup

Nies, who foresees rate cuts resuming in November and accelerating in 2026 to a 3% rate, noted that policymakers might need to maintain GDP growth below potential for longer in order to realign demand with the new supply reality.

Governor Amir Yaron previously signaled the central bank could start cutting rates in the second half of this year, provided inflation decelerated and market risk premiums remained under control.

According to Bank of Israel data, financial markets still expected inflation to ease to 1.8% in the coming year based on bond yields. The central bank’s own economists also predicted two rate cuts later in 2025.

Price-level volatility keeps interest rates on hold

Israel’s annual inflation rate accelerated in April – against an expected slowdown to 3.1% from 3.3% in March. Much of the gain in April stemmed from a spike in airfares, although inflation had been boosted throughout the year by price gains in a host of goods, including water and electricity, as well as some taxes that rose at the start of 2025. 

However, Goldman Sachs’ Johan Allen also said that the central bank may look past the higher airfares if there is continued disinflation across other core categories. Costs were expected to remain high throughout the summer holiday season, although price levels overall were slightly moderated by a stronger shekel, helped by the dollar’s weakness. 

The government also partly blamed war-related supply issues for sticky inflation, while domestic tensions were also set to be a factor for the central bank.

On Sunday, Israeli media cited tens of thousands of reserve soldiers involved in Gaza operations, which is likely to impact an Israeli economy already struggling with labor and supply shortages. In addition, multiple airlines had stopped flying to Israel following an increase in missile attacks by the Yemen-based Houthis.

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