Bank of Israel Governor Amir Yaron Talks Markets During Middle East Conflict
12:33 Share

This is an iHeart Podcast.

Bloomberg Audio Studios. Podcasts, radio, news. The past weeks and months have been dominated by discussions about unrest in the Middle East, and at the epicenter of all of it has been Israel, which has been fighting wars on multiple fronts, the latest being direct confrontation with Iran that is at least ended for now with a ceasefire agreement. For discussion on the economic ramifications of the latest conflict, we bring in Bank of Israel Governor

Amir Yaron. Governor Yaron, thank you so much for taking the time to speak with us. I want to start with the economic cost of some of the conflicts. Do you have an estimate of how much the latest war with Iran has tallied up to? Lisa, thank you for having me again on your show. Let me just start by saying, first of all, Israel has shown immense resiliency through the horrific day of the 7th of October.

We have shown recovery since then. In fact, in the past quarter, we grew just around our potential, which is about 4%. We've seen investment coming up, VC money, FDI. And nonetheless, we're still obviously quite away from where we would have been had this 7th of October not happened. Now, regarding the campaign response

with Iran and its nuclear threat. First, I should say, obviously, there's been lives taken,

structure damaged, and the budgetary cost regarding your question is around 1% of GDP. That includes compensation to workers, to structures, and the actual military cost regarding that campaign. Again, I should say the home front should be commanded on its resiliency. What we are seeing already today

is workers, merchants, workplaces coming back to their regular activity quickly. So that's on that front, I would say,

What we're seeing in markets is that markets are telling us that Israel's geopolitical risk has been significantly reduced. We're seeing it through the improvements or the appreciation of the shekel. We're seeing it through the reduction in the CDS of Israel. And so all those signs are positioning us, if this continues, if the ceasefires continues,

to go on into better economic activity down the road. Of course, we still have the Gaza and the hostages as an open issue that is weighing on the economy, but the current geopolitical situation and what markets are telling us is that they are seeing

the campaign that has been done vis-a-vis Iran as a positive outcome for Israel. Governor, there's a lot to unpack there. I want to start with just sort of the ongoing campaign or the ongoing war in Gaza, as well as just going forward over a medium term, whether you see Israel as having to ramp up defense spending for a longer period of time due to ongoing threats, even though

For right now, we are talking about a ceasefire between Israel and Iran. How much are you penciling in increased defense spending as a constant going forward rather than something that really is short and medium term? It's an excellent question. I would say

Israel has demonstrated its commitment to fiscal responsible standing. And in the last two years, which obviously involved a lot of increased defense spending, the government did two major

fiscal consolidation steps, both in the 24 and the 25 budgets on the order of 1% and 1.5% respectively. This is a non-trivial step in order to signal to the markets that our debt to GDP

basically is not going to diverge over time and in fact, over time should have a downward trajectory. Now, given the extra cost that I just mentioned with the Iranian campaign and the ongoing Gaza situation on the one hand, but the fact that perhaps geopolitical situation has been improved,

Israel is going to have to reassess its priorities regarding balancing civilian expenditures, defense expenditures, in order to maintain this responsible fiscal standing going forward.

So if you talk about having to balance a budget rather than just simply increasing debt, do you see the defense spending as being a bigger proportion overall and there have to be some fiscal restraint? I'm just wondering how you're thinking about the budget as the head of the financial aspect as well as your role as the head of the central bank. We have to decide what your response is to that on the rate side.

So first of all, for the 2025, we'll probably have to open the budget and increase it somewhat. But what I was referring to going forward, you know, the decision makers and partly once we know better how things how the dust exactly settles.

When I talk about reassessing priority, if the geopolitical situation has improved, it will allow perhaps some shifting between defense spending, civilian spending, and maybe less

increases in defense spending that were in line. You know, there was a special committee, which I was one of the advocates for it after the 7th of October to assess spending 10 years out.

And this perhaps should be reassessed given what has happened with the campaign against the nuclear threat to Iran. So whether spending goes up for defense is something that should be reassessed. And even if it's not immediate, perhaps in terms of

smoothing it over time, some of these new geopolitical events may provide such opportunities. But all of that has to be reassessed as we are going forward. Governor Yaron, you also mentioned the appreciation of the shekel as sort of a global vote. On

greater security in the region, as you're referring to, that could potentially loosen up some of the requirements on defense spending. I just wonder if, as the central bank governor, you see the appreciation of the shekel as allowing you to cut rates, as possibly reduce inflationary forces from imports.

So there are right now probably two vectors that are operating in somewhat opposite direction. On the one hand, as you mentioned, the appreciation of the shekel pushes things, holding everything else equal towards, you know, reducing inflation. On the other hand, if inflation

What we are seeing with the shekel is also a reflection of, indeed, better geopolitical view of Israel that will increase investment, will increase demand. And right now, we are still facing...

shortages on the labor side, on labor supply. This is something that I've mentioned in the past. And that, of course, is putting some pressure on inflation. Which of these two kind of comes out and at what phase is still hard to know at this point. And therefore, we have to work cautiously to

And we're going to continue to work as we've done in the recent past because inflation has been very volatile. Airfares moved, for example, inflation up by surprisingly a half percentage point. The following months, it kind of dropped. So we have to work cautiously using a data-dependent approach as we go along. We still think that a year out,

We should see the general fundamental forces pushing inflation down. But what is happening in sort of in the shorter run is hard to tell, given these forces that I just mentioned.

You talk about, Governor, you're on the prospect of a better geopolitical backdrop in the region, providing not only a boost, reducing your need to spend for defense, but also potentially providing a boost for regional travel, for business. I mean, what's your base case or and what's your some of your tail risks in terms of entail benefits from how much the situation has changed in the past week?

So we have basically a forecast that is from April. We're going to go to an official forecast in our next interest rate meeting. But I would say in general,

We think the geopolitical events are such that they are going to provide, as you say, more investments in Israel, better business opportunity. But if we go farther down the line, if this situation is sort of an opening to somehow closing the situation in Gaza where there is sustainable security,

solution there for Israel. And if other arrangements and agreements and expansion of the Abraham's Accord are down the road, that, of course, opens up even bigger economic prospects down the road. They're not in our models right now, but

But those are things that, you know, clearly some people are putting and thinking about down the road. There's just too much uncertainty how things will develop in the near future. Governor Yaron, what do you have to see in terms of Iran and Israel, some sort of further pact? What do you have to see to make that more of a base case, to understand that there is a more secure environment there?

I think, first of all, the fact that the campaign against the Iranian nuclear threat, at least as presented by both President Trump and Prime Minister Netanyahu, dismantled that threat, that's an important issue, and the markets are

sort of showing it by both by, as I mentioned, by the CDS and the Shekel. I think the next issue that is weighing on the economy right now is putting some kind of resolution to the Gaza and the hopefully getting the hostages back situation. Once that gets resolved,

resolved in a sustainable manner, we will have a clear path for Israel going back to its potential trajectory for growth and maybe even doing some catching up through the losses that have happened in the year and nine months that has happened since the 7th of October.

Learn more about the technology, insights, and support available at AmazonBusiness.com.

This is an iHeart Podcast.