“The strong shekel is good news” - until it hurts high-tech
Bank of Israel balances cooling inflation against mounting pressure on tech and industry.
The Bank of Israel’s Monetary Committee decided to lower the benchmark interest rate by 0.25% to 3.75% on Monday, bringing the prime rate to 5.25%. The decision was not surprising and was in line with the forecasts of most analysts. Behind the rate cut lies the moderation of inflation, which currently stands at 1.9%, while inflation expectations for the coming year also remain within the government’s target range of 1%-3%. The move comes four months after the previous interest rate cut in January 2026.
In addition to moderating inflation, the central bank was also influenced by the strengthening of the shekel, which has already contributed, and is expected to continue contributing, to lower inflation. On the other hand, the rapid appreciation of the currency is making life harder for exporters and could even damage Israel’s high-tech sector. Moreover, the slowdown in activity in the real estate sector, together with the absence of signs of strong growth later this year, may have led the bank to prioritize supporting economic growth over fighting inflation, which now appears to be under control.
Furthermore, it is possible that one of the main factors influencing the central bank’s decision was the emerging agreement between the United States and Iran. Even if the deal is not to Israel’s liking, it is expected to stabilize energy prices and remove one of the key risks to renewed inflationary pressure.
"Long wars lead to hyperinflation"
Governor Amir Yaron, let’s start with politics. Would you like to respond to Finance Minister Smotrich, who said the Monetary Committee’s interest rate cut was “too little, too late”?
“So he said that. What can I tell you? I remind you that we have been in a war for three years that has cost many billions of shekels. Long wars lead to hyperinflation. In practice, we have inflation that has been contained, alongside an economy that is showing resilience, market confidence, and low unemployment. I think this reflects the success of our policy, and I see all the international institutions saying the same thing. I suggest everyone read their reports.”
On the one hand, you lowered the interest rate. On the other hand, your statement mainly emphasized the risks to inflation.
“If that is the impression, then it means we succeeded in writing the statement. I’ll explain why we lowered the rate: monetary policy balances between maintaining inflation within the target range and supporting economic activity. Our policy has been successful, inflation and inflation expectations are now at the center of the target range, and we can add to that the strengthening of the shekel, which moderates inflationary pressures. This allowed us to lower the interest rate already now. The decision reflects the balance between stabilized inflation, a resilient wartime economy, and the risks to inflation, and there are quite a few risks.”
What are the risks?
“There are geopolitical risks, local risks, and global risks. If you look at the reserve duty figures and the defense establishment’s budget demands, you see there is a labor supply constraint. There is also another element that did not exist throughout much of the recent period: inflation has risen globally, and when this becomes entrenched and prolonged, it can be imported into Israel. Our decision takes all of these factors into account.”
So what does this complex message say about the future? In March, you predicted that the Bank of Israel’s interest rate in March 2027 would stand at 3.5%-3.75%.
“Before the next decision, we will update the forecast, but we will not be far from the forecast we discussed in March. The interest-rate path will remain measured and cautious. It will depend on geopolitical developments, fiscal policy, and economic activity. That is how we have acted until now, and we will continue to do so. Things can change in the blink of an eye. I list all these risks to make clear that there is no risk-free horizon here, we are not on a path where further declines are guaranteed.”
What is happening with the strengthening of the shekel, and under what conditions would you intervene?
“The strengthening of the shekel reflects a certain resilience and durability of the Israeli economy, and that is good news. A strong shekel brings, and will continue to bring, some relief in the cost of living. It should also be remembered that the shekel strengthened after a major depreciation. The shekel is heavily influenced by geopolitical events, and since the beeper operation it has been strengthening. There are three main factors behind this: the decline in Israel’s risk premium, the strength of the U.S. stock market and its connection to Israeli institutional investors, and the weakening of the dollar globally.”
And what about the interest-rate gap? Wasn’t that also a factor in the shekel’s appreciation?
“The interest-rate gap really wasn’t a major factor, if at all. But now that we have lowered rates, while the Federal Reserve and the European Central Bank are moving toward higher rates, the interest-rate gap has narrowed.”
And what about intervention, such as purchasing foreign currency now that rates are lower?
“I do not take exporters’ difficulties lightly. We are constantly monitoring the situation, but we must remember that a central bank is not supposed to fight fundamental economic forces. We also saw growth in exports in the last quarter. Intervention is a tool in the Monetary Committee’s toolbox, but it is intended for specific and temporary situations, for example, when inflation is very low or when there is market dysfunction. We are not in that situation right now. We intervened when inflation was negative, and we intervened when markets malfunctioned at the start of the war. We do not rule out intervention in principle, but the conditions have to justify it.”
So what should be done for exporters?
“If you ask me, there is room to consider targeted fiscal support for exporters suffering from the low dollar exchange rate, to provide something of a transition period, because we are seeing a more structural change in the exchange-rate environment.”
Calcalist reporter Sophie Shulman published a report this week about layoffs in high-tech caused by the combination of AI and the strengthening shekel. Is it possible that we should now worry more about unemployment and weakening economic activity than about inflation?
“There is a structural change resulting from artificial intelligence. It benefits companies in sectors such as semiconductors, but creates greater challenges for software companies. This is happening all over the world, and companies will have to make the necessary adjustments. We still do not see a rise in unemployment, and we have additional data that we process and do not necessarily present publicly. We do not look only backward, but also sideways and forward. We understand that the exchange rate has an impact, but it also reflects changes in fundamental economic forces. At the same time, we are seeing data that points to recovery, such as credit-card spending.”
"Uncertainty regarding the increase in the defense budget"
The Monetary Committee’s statement accompanying the interest-rate decision actually opened by highlighting two factors that do not support a rate cut. The statement said that “geopolitical and global uncertainty remains significant” and that “since the previous interest-rate decision, there has been a sharp increase in the global inflation environment.” The committee further noted that “there are risks of a renewed rise in inflation.” These risks include “geopolitical developments and their effects on economic activity and energy prices, increased demand alongside supply constraints, and fiscal developments.”
Later in the statement, the bank elaborated on the “supply constraints” resulting from the war, primarily the large number of reservists and workers absent from the labor market for war-related reasons. The bank stressed that unemployment remains low and that the number of job vacancies increased in April. In addition, wage growth remains elevated and stable.
Regarding fiscal policy, the bank noted that tax revenues had surprised positively and remained above the long-term trend line. At the same time, however, “there is uncertainty regarding the increase in the defense budget, and with it an increase in the deficit ceiling.”
Despite these concerns, the bank still chose to lower interest rates, citing several supporting factors. The first is, of course, that inflation currently stands at 1.9% and inflation expectations for the coming year are also within target. Another key factor highlighted by the committee was the strengthening of the shekel. Right at the beginning of the statement, the bank noted that the shekel had appreciated by 8.3% since the previous interest-rate decision six weeks earlier. The statement added that “the appreciation of the shekel may contribute to moderating inflation.”
Beyond inflation, the committee also reviewed broader economic activity and suggested that the economy requires support in the form of lower interest rates. Although economic activity in the first quarter of 2026, the “Operation Roaring Lion” quarter, was stronger than during the “Rising Lion” quarter, GDP still remains about 4.5% below its long-term growth trend.
There was also a decline in business sentiment surveys. In particular, there was an increase in the share of businesses across all sectors reporting tighter credit conditions, an indication that high interest rates have begun to weigh on economic activity. Venture-capital fundraising in the high-tech sector also declined during the second quarter of the year. The committee additionally pointed to stagnation in the real estate market, where approximately 85,000 new apartments remain unsold.
Although the business sector had expected an interest-rate cut, reactions to the move were still critical, with some arguing that the Bank of Israel should have reduced rates by 0.5% rather than 0.25%.
