The interest rate decision is approaching: the drama behind the scenes at the Bank of Israel is revealed
The Bank of Israel is preparing for a fateful decision in the shadow of surprising data from the labor market and inflation, as senior economists now estimate the real chance of a revolution in the interest rate in the coming days.
Yonatan Katz and the economists of Leader Capital Markets conducted their weekly economic review, focusing on the approaching interest rate decision, the low inflation environment, and the certain moderation in the labor market that will influence the decision and the low yield in Israel.
"The interest rate decision is approaching: as the interest rate decision nears, the deliberation continues. The Governor's remarks on Bloomberg were relatively hawkish and slightly reduced expectations for an interest rate cut on September 1st. Below are the key considerations: the level of geopolitical tension significantly affects the interest rate decision. Despite the mutual threats between Donald Trump and Iran, Israel is not involved at this stage, but it is clear that the various fronts are still not completely quiet. Israel's risk premium remains low, both according to CDS and the yield gap between the USA and Israel. The shekel also remains relatively strong.
The inflation environment is currently low and is a factor supporting an interest rate cut. General inflation stands at 1.5% year-on-year and core inflation at 1.4%. However, the Bank of Israel attaches great importance to the inflation rate expected in the coming months. The Governor noted that according to forecasters' projections, inflation is expected to return to a rate of 2.0% in the coming months. According to our forecast and that of most forecasters, this is expected to happen in September, albeit temporarily due to the holidays being earlier this year compared to last year.
The recovery in economic activity is a factor supporting no change in the interest rate. The Governor referred to the rapid growth of 15.4% in the second quarter, but also noted the reservation regarding 'exports that do not cross the country's borders' (mainly Nvidia). Even excluding this component, the economy grew by 14.4% in the second quarter.
Looking at the first half of the year, the gap is more significant, with moderate growth of only 1.0% compared to 3.2%, while private consumption fell by 0.5%. However, the Governor emphasized the strong growth figures, with business output, including Nvidia, being only about 1% below the long-term trend. An initial indication of activity at the beginning of the third quarter is obtained from the Bank of Israel's composite index, which fell in July by 0.12% compared to June.
Labor market data point to a certain moderation in the degree of tightness. The unemployment rate rose in July to 3.1% (seasonally adjusted) compared to 2.9% in June, in parallel with an increase in the participation rate to 62.2% from 62.0%. The increase in the number of job seekers reduces the pressure in the labor market to some extent. On Tuesday, employment data for the 25-64 age group will be published, a figure of importance for interest rate considerations.
The global environment has again become somewhat challenging for the Bank of Israel, mainly against the backdrop of the renewed rise in global oil prices. On the other hand, the probability of an interest rate hike by the Fed has decreased following the moderation in inflation and certain signs of weakness in the labor market, including a moderation in the pace of wage increases. In parallel, price pressures in the purchasing managers' indices in August moderated, despite an acceleration in activity, particularly in the services sector.
At this stage, we estimate a 60% probability of an interest rate cut on September 1st, as long as the shekel stabilizes below 3.0 NIS to the dollar, but we will update the assessment next week.
Bond market: the drama of the last week was the attempt by the US Treasury Secretary to curb the rise in long-term yields by expanding the buyback program for long-term bonds. The move provided only temporary support, as a combination of skepticism regarding its effectiveness, fiscal concerns, and increased fundraising in the corporate market returned the yield on 10-year US bonds to the level of 4.74%.
In Israel, the yield on 10-year bonds is 80 basis points lower than the equivalent yield in the USA. The uncertainty surrounding developments ahead of the elections in Israel is expected to hinder the potential for capital gains on long-term instruments in the near term."
