The real interest rate in Israel (that is, the interest rate taking into account inflation) is the highest in the West, by a long way. Even the Bank of Israel’s nominal rate of 4% is higher than central bank rates in almost every other country. Together with fairly low inflation (and low inflation expectations), Israel has become an outlier for its real interest rate level.
Fears of inflation and geopolitical upsets shape the Bank of Israel’s conservative approach, as does the fiscal deficit. This, according to some experts, is also strengthening the shekel in relation to the US dollar. The shekel-dollar exchange rate is at its lowest in over thirty years. So when, if at all, will we see interest rates falling?
“Counterweight to the fiscal deficit”
The Bank of Israel’s interest rate is currently 4%, while the International Monetary Fund’s forecast for inflation in Israel in 2026 is 2.3%, slightly higher than the current rate, but within the 1-3% target range. This puts the real interest rate in Israel at 1.7%.
This is a very high rate in comparison with the rest of the world. In the US and the UK, the same calculation puts the real interest rate at just 0.5%, while in the EU, Canada, and Japan, the real interest rate is actually negative. Even if the European Central Bank raises its interest rate shortly, as the market expects, that will bring the real rate in the EU to about zero, far below the current real rate in Israel.
How has this arisen? Meitav chief economist Alex Zabezhinsky says, “The Bank of Israel is keeping its interest rate very high mainly because of fears of inflation. It is concerned that although the rate of inflation is fairly low at present, circumstances in Israel, among them the war, raise the risk of inflation because of supply problems and limitations on imports. In addition, people are on military reserve duty and there are fewer workers, which translates into pressure to raise wages, and that affects inflation down the line.”
CIal Insurance chief markets strategist Amir Argaman adds, “Every time the Bank of Israel has spoken recently, it has referred to the high government deficit which is liable to fuel inflation, and the high interest rate as a counterweight to it.” So if the government managed to reduce the deficit, the Bank of Israel would be freer to lower its interest rate.
“As far as avoiding damage is concerned, economic growth is reasonable, and the fact that the Israeli economy can continue growing at this rate means that the 4% nominal rate is a restraint, but it isn’t strangling the economy,” Argaman says. He adds that central banks all over the world don’t want to go back to the period of very low interest rates, which led to negative effects such as “inequality, excess liquidity, and inflated asset values.”
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Zabezhinsky says however, “There is actually room to lower the interest rate, because inflation in Israel is no higher than in other places. Energy prices are not having a great deal of impact, because the cost of fuel mainly consists of taxes, and the price of locally produced natural gas has not changed.” Unlike Argaman, who describes Israel’s economic growth rate as “reasonable,” Zabezhinsky says, “Our growth has been low for three years now.” The gap between them probably arises from different reference periods. Following the economic downturn at the beginning of the war, growth has still not returned to normal, but in the past year it has recovered considerably.
From the shekel to real estate: Effects on the economy
One effect attributed to the high interest rate is the strengthening of the shekel. In theory, interest rate gaps attract capital to where the interest rate is higher, which tends to strengthen the currency, and the capital market. “A high real interest rate attracts foreign capital and strengthens the shekel,” says Argaman. “As a tool for managing short-term liquidity as well, for anyone who wants to park his money for a week or a month, the shekel is an excellent place. That strengthens the shekel, which helps to curb inflation, but makes exporting harder.”
Zabezhinsky, by contrast, argues that the figures on the ground don’t match the theory. “In January, in a surprise move, the Bank of Israel cut its interest rate by 0.25%, and that had no appreciable impact on the shekel. Movements on the US capital market and actions by local financial institutions have a greater effect.”
Other effects of the high interest rates are on economic activity, particularly in real estate. “The high real interest raises the cost of debt for firms and for households. That hits investment and consumption,” Zabezhinsky points out, and observes, “They’re passing a law to subsidize mortgages, when it would be better simply to cut interest rates.”
Argaman agrees that at a basic level the situation encourages saving at the expense of consumption, which slows economic growth, and of course it raises the cost of government debt. “In addition, it affects the real estate market: the high long-term interest rate, which is the basis for mortgage rates, is creating high financing costs which reduce the level of mortgage taking and act as a brake on economic activity in general and activity in real estate in particular. All the special financing offers by developers are an attempt to circumvent this.”
The forecast: Two more interest rate cuts this year
Argaman thinks that the Bank of Israel is behaving in a professional manner in relation to the contradictory constraints acting upon it. “Assuming that there is no further military escalation, which is what the markets are currently pricing, the Bank of Israel will carry out one or two interest rate cuts by the end of the year.”
Even after a 0.5% cut, the Bank of Israel’s rate will still be high relative to the rest of the world. “At the moment, the US central bank is not expected to change its interest rate, which allows the Bank of Israel to conduct a more finely-tuned and moderate policy,” Argaman says.
Zabezhinsky sounds a little more enthusiastic for an interest rate cut. “If there’s a substantial risk of inflation, there’s justification for the high interest rate, but there’s risk in other countries too, and the real interest rate there is nevertheless lower than here. The Bank of Israel can take measured steps and reduce its interest rate.”
Published by Globes, Israel business news – en.globes.co.il – on May 13, 2026.
© Copyright of Globes Publisher Itonut (1983) Ltd., 2026.
