Israel’s Markets Soften: Falling Prices and a Strong Shekel Leave Room for Further Rate Cuts

In Jerusalem, monetary policy is moving through a quieter season. The numbers have not disappeared beneath the noise of a volatile regional environment, but inflation has offered the Bank of Israel a little more room to breathe. On September 1, the central bank lowered its benchmark interest rate by 25 basis points to 3.25%, its third consecutive reduction and the lowest level since late 2022.

The decision placed Israel on a different path from several major economies where inflation remains a reason for caution. Annual inflation stood at 1.5% in July, comfortably inside the Bank of Israel’s 1% to 3% target range and below its preferred midpoint of 2%. Deputy Governor Andrew Abir said the recent decline in inflation had removed much of the immediate reason to keep borrowing costs at higher levels.

The shekel has also played an important part in that landscape. A relatively strong currency can reduce the domestic cost of imported goods, creating another channel through which price pressures can soften. For policymakers, the combination of subdued inflation and currency strength has therefore become part of the broader picture behind the recent easing cycle.

Yet the path ahead is not being presented as automatic. Abir indicated that additional cuts could follow if inflation continues to move lower, while a renewed rise in prices could encourage the central bank to pause. The response of households, businesses and financial markets to the latest reduction will also help shape the next decision.

That caution matters because Israel’s economic growth figures carry more than one story. The economy expanded at an annualized rate of 15.4% during the second quarter, a striking headline number. But Abir noted that a substantial part of that increase came from production by Israeli companies abroad, meaning the underlying domestic picture was considerably less dramatic.

When overseas production is excluded, second-quarter output was only 3.8% higher than in the final quarter of 2025 on an annualized basis. The distinction gives policymakers a more measured view of economic momentum and helps explain why strong headline growth alone does not necessarily close the door on monetary easing.

For households and companies, lower rates can gradually change the cost of borrowing. Mortgage payments, business credit and other forms of financing can respond as monetary conditions loosen, although the effect depends on the structure of individual loans and the speed at which financial institutions pass through changes in the policy rate.

The central bank’s economists currently see the possibility of the benchmark rate reaching around 3% by the middle of 2027, although that projection remains dependent on incoming data. The next policy decision is scheduled for October 21, giving officials several weeks to observe inflation, currency movements and the economy’s response to the latest cut.

For now, Israel’s monetary landscape appears to be defined less by a dramatic turn than by gradual movement. Prices are relatively contained, the shekel remains comparatively strong, and the central bank has left the door open to further reductions. The next steps will depend, as Abir emphasized, on what the data reveal as autumn advances.

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Sources: Reuters Bank of Israel