UPDATE 2-Bank of Israel eases but Iran war worries to keep future cuts gradual

The Bank of Israel lowered short-term interest rates for the first time since January on Monday, citing a large appreciation of the shekel and stable inflation, while cautioning that future cuts will be gradual since uncertainty over ‌the Iran war remains high. The central bank, as expected, reduced its benchmark rate to 3.75% from 4%. It had cut in November and January but paused in its two subsequent decisions due to the conflict with Iran and fears of a spike in supply-driven inflation. That annual inflation held at 1.9% in April, well ‌within a 1-3% target range, was the main factor in easing policy, according to Bank of Israel Deputy Governor Andrew Abir.

Keeping inflation at bay has ‌been a steep appreciation of the shekel to a 33-year high versus the dollar. "That certainly gives us the room to be able to cut rates - even with the geopolitical uncertainty," Abir told Reuters.

Still, while geopolitical risks have fallen, they have not disappeared and "that means that we have to be more careful in the pace in which we change interest rate," he added. The ⁠Bank of ​Israel's staff in March had forecast two ⁠rate cuts by early 2027, or a policy rate of 3.5%. Future rate cuts, Abir said, would be data dependent.

The U.S. and Israel launched airstrikes on Iran on February 28. A ceasefire ⁠forged on April 8 has held but remains fragile. "A continued war and escalation of it would have an impact both on the real economy and probably on inflation ​as well," Abir said, noting the economy remained strong. "Even if there is a sudden shock it's unlikely that (inflation) goes up to" the top of ⁠the inflation target range of 3%. "That gives us a sort of the comfort that we can cut rates ... and we can do it in a gradual pace," he said.

With the ⁠shekel ​strong, exporters had been pushing the central bank for rate cuts or intervention in the foreign exchange market. Despite the rate cut, the Manufacturers' Association criticised the move, believing more monetary stimulus was needed to protect economic growth. Similarly, Finance Minister Bezalel Smotrich called the quarter-point move "too little, too late" and that a ⁠larger cut was needed "to make things easier for exporters, households and business owners."

The shekel gained 0.4% against the dollar to a 2.88 rate, while Tel Aviv shares ⁠rose 3.2% on Monday. "We are not ⁠trying to surprise the markets," Abir said. "We're trying to set a level of monetary policy that is commensurate with the expectations for inflation and what's going on in the real economy.

"We've been in a fortunate situation that we've ‌managed to bring down inflation, ‌and yet the monetary tightening ... hasn't led to an increase in unemployment."

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