A Stronger Shekel and Cooling Inflation Build the Case for an Israeli Rate Cut

Israeli shares rose on Monday, with the Tel Aviv 35 index up about 0.9 percent and the construction and real-estate index climbing around 3.6 percent, according to Globes. The financial daily reported that Bank Hapoalim sees falling inflation expectations and a strong shekel supporting an interest-rate cut in July.

The backdrop is a currency that has appreciated sharply since the ceasefire that paused the regional conflict. The Bank of Israel cut its benchmark rate to 3.75 percent in May, its second consecutive reduction, citing a stronger shekel, contained inflation near the midpoint of its 1 to 3 percent target, and the prospect of an end to the war. The shekel had appreciated more than 8 percent against the dollar since the prior decision.

A firmer currency lowers the local-currency cost of imports and reduces inflation, which gives the central bank room to cut rates. The risk is that easing too quickly, while postwar reconstruction spending and a rising equity market add demand, could revive the price pressures the bank has worked to contain.

The episode is a clear example of how the easing of a conflict directly affects monetary policy, through a stronger currency, lower risk premiums and renewed confidence among investors.